Hermes Investment Management says investors have been wary of investing in US financial stocks since the global financial crisis, but this is about to change as opportunity beckons in the sector.
Michael Russell, portfolio manager at Hermes says that despite a low interest rate environment putting pressure on banks' bottom lines, they've touched their highest levels since the crisis in 2017.
But valuations remain attractive and a combination of tailwinds are about to help the sector break out from a decade-long bear market.
Tailwinds in 2018
- Deregulation: President Trump has appointed Randal Quarles as the US Federal Reserve’s supervisory chief to dismantle regulations that have burdened banks since the global financial crisis. Quarles is expected to loosen regulation on the sector which will reduce compliance costs and help banks grow their loan books
- Tax reform: The Republicans passed the most radical overhaul of the US tax system since the 1980s with President Trump signing the legislation which contained a reduction in the corporate tax rate from 35% to 21%, which will serve to boost bank earnings
- Central bank action: The current pace of Fed interest rate hikes (2-3 per year) is likely to continue given the underlying economic growth rate of 3%. As interest rates rise, banks are able to price loans at higher rates, and thereby earn higher returns
- Revenue momentum and positive revisions: Financials enjoyed a stellar third-quarter earnings season in 2017. Revenues grew at a rate of 4.8% in the third quarter, compared to a 12-quarter average of just 1.5%, according to Zacks Investment Research. Earnings forecasts were revised upwards which also reflects a robust economy
Hermes' has an optimistic outlook for the sector and holds stocks with a "durable competitive advantage". It notes Bank of America and Citigroup "both with dominant franchises" as its preferred stocks.
"Bank of America has an impressive market share, holding 10% of the US checking and savings account market, and nearly 15% of credit cards," says Russell.
Meanwhile, Citigroup has a global footprint, with leading positions in credit cards and wealth management across the US, Asia and Mexico.
Russell says: "The bank is poised to become a beneficiary of regulatory changes in the US, which should help it achieve dividend and share buyback returns of 10% a year."