A revival in financial companies is one of the only bullish things left to happen in a market where $15 trillion has been restored to stock prices over seven years.
While banks and brokerages have posted some of the S&P 500’s biggest gains since markets bottomed in March 2009, the trajectory mostly reflects the speed at which they plunged in the 18 months before that. The financial industry is by far the index’s worst performer since the end of the last bull market, falling more than 30 percent since October 2007 compared with gains of 75 percent or more in consumer, technology and healthcare.
The bull case on banks turns on expectations that higher interest rates will increase the profitability of their lending operations. Earnings for the financial sector of the S&P 500 are forecast to rise 8.1 percent next year, exceeding the rate of the full index. Goldman Sachs estimates the Fed will raise its benchmark rate to 3.5 percent by the end of 2016.
Even if a 25-basis-point change won’t directly affect profit very much, the public’s shift in attitude, “to my investors, is great news because a bank is entirely a reflection of the people we service,” he said.
Wells Fargo CEO John Stumpf, who runs the largest U.S. mortgage lender, said it gives the public more evidence that the economy is moving beyond the financial crisis. Wednesday’s market’s reaction “was a confidence rally,” he said in an interview. “I think the move is more important than the rate. And it says ‘Yes, things are better than they were when we put this exceptional accommodative policy in place.”’
At the same time, concern about the volume of trading on Wall Street has been pushing estimates down for the current quarter. Industry profits are projected to be unchanged from a year ago in the three months ending Dec. 31 after estimates fell at the fastest rate in four years.
While many banks are well positioned to benefit from higher rates, the start of a tightening cycle signals new challenges for the industry, according to Devi Aurora, primary credit analyst at S&P.
“This will present new, but not entirely unwelcome, challenges for bank managements with regard to funding and capital, and the pace of deposit repricing will become a key factor to monitor,” Aurora wrote in a Wednesday note titled “2016 U.S. Banking Outlook: It’s All About That Rate, ’Bout That Rate.” “We expect some shifts and possible repercussions for banks’ funding, balance sheets, and capital.”
After spending the years since 2007 cutting costs and repairing balance sheets, banks and brokerages have become the biggest profit contributor to the S&P 500. They earned a combined $172 billion in the first nine months of the year, more than any other industry over the period. At 1.4 times book value, the industry is cheaper than all others in the S&P 500. The ratio stands at 2.8 for the broad index.
“Financials come up pretty favorable,” Mark Spellman, a fund manager who helps oversee $4.2 billion at Alpine Funds in Purchase, New York, said by phone. “Part of the story is higher rates are going to lead to higher profitability and higher stock prices. You don’t have a high P/E in them, so you’re more comfortable making that bet.”