The outlook for financials is improving, paving the way for a broader return in value indices and exchange traded funds.
The ETF (ticker: XLF) is up around 23% since early November, beating the
it’s 10% gain. Financials represent the largest weighting in the
IShares Russell 1000 Value ETF
(IWD) at 24% of the total. This ETF is also outperforming, up 15% over the past three months.
Banks and other financial firms are benefiting from a few factors: A steepening in the yield curve is fueling optimism that net interest margins, essential to bank profits, will recover sharply. Big banks have the green light from regulators to resume share buybacks. The sector is also on the rise in hopes that the economy will recover strongly in the second half of 2021, fueling lending activity and reducing credit losses.
Financial companies posted strong fourth quarter earnings.
Bank of America
(WFC) all beat consensus earnings forecasts. Investment banks
(MS) exceeded estimates, as did brokerage
(SCHW) and financial data firm
While the industry has collapsed somewhat this earnings season, Wall Street is more and more bullish.
According to Scott Opsal, director of research and actions at Leuthold Group, financials could now be the “franchise quarterback” that will lead a recovery in value.
Value and financials are closely synchronized and tend to move in tandem during market cycles, he wrote in a report Thursday. The stock exceeded growth by 96% in total from June 2000 to May 2007. Financials beat the S&P 500 by 59% over the period, Opsal notes. The stock then lagged growth for more than 13 years, underperforming an aggregate 55% through August 2020. Financials followed the S&P 500 by 64% during that time.
“When financiers are ‘on’ their game, a winning outcome for value seems likely,” writes Opsal. “But if Financials is in the funk, the rest of the team are struggling to overcome a poor performance by their star player.”
Value has lagged so far behind growth – 220% underperforming over the past decade – that reports of a return have become a common joke. Legions of false starts have fueled skepticism about whether this time will be any different, as growth has grown increasingly, led by Big Tech.
A change in market leadership from growth to value would force investors to forgo technology, which accounts for 55% of the Russell 1000 Growth ETF. This can be a tall order, with many large tech stocks beating earnings estimates. Investors should also gain confidence in healthcare and industrials, the second and third sectors of the Russell 1000 Value ETF.
The rise in long-term interest rates and the steepening of the yield curve should encourage a rotation of values. Its duration will depend on the acceleration of the economy as vaccines slow the pandemic. Banks will also have to do their part by beating Wall Street estimates, with other value sectors taking a back seat.
Write to Daren Fonda at [email protected]