The rally in financial stocks has been so strong that they have outperformed tech—the darling of the pandemic—since the bear-market low last March. Don’t expect that to end any time soon.
The price movements of almost allfinancial assets have reflected expectations for higher economic growth and inflation since September. Perhaps most importantly, interest rates have taken off, with opposite effects on the two sectors.
Banks lend more when the economy is healthier, and have to set aside less money to cover potential losses on loans. At the same time, each loan is more profitable iflong-term interest rates riserelative to short-term borrowing costs, as they have recently. Banks pay short-term rates for funds they get from depositors and in the money market, and lend that cash out at long-term rates, for periods of as much as 30 years,
The same rise in rates—the yield on the 10-year Treasury note more than doubled since September—has eaten into the valuations of stocks, reducing the present, discounted value of money to be earned in the future.It is a particular problem for hot growth stocks, many of them in the tech sector, because most of their earnings are expected to come years from now.
Now, theFinancial Select Sector SPDR Fund(ticker: XLF) is up almost 90% since the low of the pandemic-induced bear market. TheTechnology Select Sector SPDR Fund(XLK) is up 82%.
“Thanks to investors resetting their view on interest rates, there has been a swift and meaningful rotation out of technology stocks and into financials,” wrote Jason Goepfert, founder of Sundial Capital Research. In roughly the past year, the aggregate value of tech stocks has fallen to about five times that of financials, compared with 6.4 times.
It isn’t too late to move into financial stocks.
The economy is reopening, the government has spenttrillions of dollars to prop up growth, and many consumers and businesses are ready to spend. Prices for financial stocks reflect how they could benefit from all that, but several factors indicate the group may have more room to run.
First,many observers expect the 10-year Treasury yield to hit roughly 2% by year-end, a major positive for bank profitability. So long as the Federal Reserve doesn’t lift interest rates too high before the economy can handle it, loan volumes shouldn’t suffer. Earnings growth for financial companies in the S&P 500 could be 12% in 2022 , according to FactSet data.
Plus, financial stocks’ valuations are low. Their ratios of stock prices to expected 2022 per-share earnings are 30% lower than for the average stock in the S&P 500. Historically, financials trade at multiples in line with the index, according to research from RBC Capital Markets.
The fact that a group of stocks is hot doesn’t disqualify it as one to buy.