With interest rates on the rise and likely deregulation under the Trump administration, the financial sector should benefit. On a relative value basis, the sector remains attractive and can continue to outperform as rates rise and the burden of a heavy regulatory environment is lifted, boosting profitability.

For banks, a main component of the financial sector, the recent spike in long-term rates should prove good for profits. If the U.S. Federal Reserve (the Fed) continues a measured pace this year, shorter rates should rise slower than the move experienced on the long end of the curve. This should improve net interest spreads, the difference between the rate paid on short-term deposits and the rate charged for longer-term loans. Insurance companies should also benefit from higher rates. Property and casualty insurers, which usually have shorter duration fixed income portfolios, should do especially well under this scenario. These companies profit from the return they make on their investment portfolios over the amount they pay out in claims. As investments are made at higher interest rates, the earnings for insurance companies stand to improve.

However, not all financials companies will benefit from higher rates. For example, rising rates tend to hurt financial institutions whose profitability is heavily dependent on fixed income trading as that business slows. Despite this, the broad financial sector should continue to do well in this environment.

The financial sector has been hampered by regulation under Dodd Frank since the financial collapse.  Dodd Frank has made it difficult for many of these institutions to conduct business the way they use to.  Additionally, compliance costs have soared for many of the financial companies. A healthy financial sector is crucial for the economy, so the Trump administration will likely attempt to roll back to some degree regulations or how they are enforced. Capital requirements and stress testing has limited the banks’ ability and willingness to lend, while the Vockler Rule has stopped proprietary trading by investment banks, thus impacting market making operations. Finally, many regulations, including the pending Department of Labor fiduciary rule set to be implemented this spring, have increased the costs and likely will have a negative impact on revenue for broker dealers and the investment divisions of many financial sector companies. Any relief from heavy regulation on the financial sector should be a positive for fundamentals in the sector.

For investors wanting to gain exposure to the Financial sector, there are several ETFs available. The SPDR Financial Select Sector (XLF) provides diversified exposure to U.S. financials including banks, insurance, financial services, and capital markets. For global financial sector exposure, investors may consider the iShares Global Financials ETF (IXG), which holds approximately 55% foreign financial sector equities. For more targeted exposure, the SPDR S&P Bank ETF (KBE) and the Powershares KBW Property and Casualty Insurance ETF (KBWP), among others, give investors more specific financial sector exposures.

At the time of writing, Stringer Asset Management LLC (SAM) clients owned IXG. SAM is a Memphis, TN third-party investment manager and ETF strategist. Contact SAM at 901-800-2956 or at [email protected].

The views expressed herein are exclusively those of Stringer Asset Management LLC (SAM), and are not meant as investment advice and are subject to change. Information contained herein is derived from sources we believe to be reliable, however, we do not represent that this information is complete or accurate and it should not be relied upon as such. All opinions expressed herein are subject to change without notice. This material does not constitute any representation as to the suitability or appropriateness of any security, financial product or instrument. SAM is not making any comment as to the suitability of any funds mentioned, or any investment product for use in any portfolio. There is no guarantee that investment in any program or strategy discussed herein will be profitable or will not incur loss. This information is prepared for general information only. Investors should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Investors should note that security values may fluctuate and that each security’s price or value may rise or fall. Accordingly, investors may receive back less than originally invested. Past performance is not a guide to future performance.

About the Author: Kim Escue

Kim Escue is co-founder and Senior Portfolio Manager of Stringer Asset Management. Ms. Escue is responsible for security selection, as well as helping develop the firm’s short-term and long-term asset allocation strategies. She holds the Chartered Financial Analyst designation and is a member of the CFA Society of Memphis. She is also a frequent contributor to various industry publications.

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