Why We Still Like Financials

Welcome to RBC’s Markets in Motion podcast, recorded March 4th, 2021. I’m Lori Calvasina, Head of US Equity Strategy at RBC Capital Markets. Please listen to the end of this podcast for important disclaimers.

One of the things we’ve been talking about a lot with investors recently has been how we still see opportunity in reflation trades.

The big thing you need to know today:  we are reiterating our overweight on Financials, one of the most important pieces of that reflation trade.

If you’d like to hear more, here’s another 3 minutes. 

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Now, the details.

Financials is the 2nd best performing sector in the S&P 500 so far this year, and it’s leadership has really been accelerating over the past week. We are sticking with the sector for six reasons.

  1. First, a highly optimistic boots on the ground assessment by RBC’s Financials analysts.
    • Earlier this year, we conducted a survey of RBC’s US industry analysts. We were surprised to find that our analysts had a more bullish outlook on Financials than the other major sectors, driven by better expectations for performance and valuation.
  2. Second, a strong cash deployment and shareholder return profile.
    • Financials looks good from a dividend perspective, with a dividend yield that’s still well above the 10 year Treasury yield – something that’s no longer true for the broader S&P 500.
    • Additionally, buybacks are resuming – the pace of new announcements has started to really pick up.
    • Banks M&A is also starting to materialize – something that has been long overdue.
  3. Third, a very strong earnings profile.
    • Financials has been the best sector in the S&P 500 on the rate of upward EPS estimate revisions recently, tracking ahead of all other major sectors.
    • This is an important gauge of earnings sentiment. In recent years, the Growth part of the market – sectors like Tech – have been stronger than the Value part of the market on this indicator. But recently the pendulum has swung back in Value’s favor slightly, due in large part to Financials.
  4. Fourth, deeply attractive valuations relative to the S&P 500.
    • Despite strong performance since last fall, this sector still looks deeply undervalued when we compare it’s forward P/E multiple to the S&P 500.
    • On a related note, when we look at the sector’s market cap share in the S&P 500, we find that it returned to Financial Crisis lows last year and is still in the early innings of a rebound.
  5. Fifth, favorable macro tailwinds tied to the unfolding economic recovery.
    • The sector tends to outperform when ISM new orders, 10 year yields, and inflation expectations are rising, and when the yield curve steepens.
    • One thing that really jumps out to us is how the move in Financials that’s been seen has lagged the pick up in ISM new orders – we think Financials is undergoing a catch up trade with economic expectations.
  6. Sixth, improving ETF flows, signaling investor re-engagement.
    • We wouldn’t normally get so excited about ETF trends, but there has been a major reversal here – after several years of very weak flows, there’s been a major sea change here.

Beyond the macro tailwinds dissipating the main risk to our call is that two important camps of investors - hedge funds and ESG funds - have been underweight the sector.

But hedge fund underweights have narrowed

and ESG risk scores for the sector are improving, muting our concerns on this front.

That’s all for now. Thanks for listening. Please reach out to your RBC representative with any questions.