- Lori Calvasina of RBC says the recent recovery in financials should grow even stronger.
- She says the stocks are as cheap as they’ve been in a long time ahead of an economic rebound.
- Calvasina adds that trends like ETF flows and M&A activity should help support the sector.
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RBC says investors can bank on banks in the months ahead.
Financials have come to life recently as Wall Street reacted to signs of strength in the economy and rising expectations for interest rates, which are vital for banks’ profits. The sector’s 12% year-to-date gain is second-best among the 11 on the S&P 500, outpaced by the energy sector which is also benefitting from optimism about the recovery.
RBC’s Head of US Equity Strategy Lori Calvasina says her firm is optimistic about financials, and remains positive on equities even in a period of rapid change.
“While our sentiment/positioning work continues to highlight froth in US equities, it’s still not clear that the top is in,” she wrote in a recent note to clients.
Calvasina notes that the yield on the 10-year Treasury note is now about the same as the yield of the S&P, a state of affairs that serves as a “dampener” on returns. But times like this, with parity between those yields and rising real yields as well, is still positive for stocks.
Meanwhile hedge funds are getting more interested in financials, and the sector’s ESG scores are improving, which could contribute to future buying. That could serve as a tailwind.
Calvasina adds that in the near future the market is likely to weaken temporarily before a sustained rally takes root. That typically happens in the early stages of a new
“Historically, Financials underperforms when these consolidations take place,” she wrote. “But even if that occurs, we’d stick with the sector since it’s also tended to outperform in the second leg of the recovery that takes hold afterwards.”
Her team surveyed RBC’s analysts and concluded that they are very bullish on banks, insurance brokers, property and casualty insurers, and specialty and consumer finance companies. They are bullish on life insurers, payments companies and payment processors, as well as regional banks and asset managers.
Thorough optimism from analysts is the first reason Calvasina names the sector a top pick.
“RBC’s Financials analysts have been optimistic on performance, cash deployment (buybacks, dividends, M&A), margins, and fundamentals for the sector, and have also seen compelling valuations,” she wrote. “On overall industry performance and valuation in particular, their level of optimism exceeded that of most other sectors.”
The spending and shareholder returns are part of a broader pattern of financial firms having strong cash deployment profiles and putting money to work in ways that will benefit the stocks.
“New buyback announcements for the sector have been on the rise again,” she wrote. “Few dividends have been cut in Financials relative to other sectors … This seems particularly important today given the recent increase in 10-year Treasury yields, which has somewhat diminished the
appeal of the broader US equity market.”
She adds that M&A is rising after hitting a long-time low last May. And while the signs for buybacks look good, she adds that earnings revisions are also good. In fact, her analysis shows that the rate of earnings revisions from analysts are better in financials than in any other market sector.
If that weren’t enough, she argues, the stocks are cheap.
“Despite a strong run over the past few months, Financials remains deeply compelling on forward P/E relative to the broader S&P 500, even lower than its 2015-2016 growth scare lows,” Calvasina wrote.
She backs up that point with this chart.
The economic recovery is also a highly favorable one for financials. Calvasina says they usually outperform when manufacturing is rising, interest rates are up, the yield curve is steepening, and inflation expectations are up — and all of that is happening.
However the recent improvement in manufacturing orders hasn’t sunk all the way in for financials even though they usually move “in lockstep,” she says.
Finally, money is flowing back into financials. They were a longtime laggard, but ETF buyers are starting to see their appeal, if only because of their previous disinterest.
“After years of weak ETF flows, there’s been improvement for financials lately and they’ve been one of the stronger sectors in 2021,” Calvasina says.