- CNBC.com – Dow set to climb 100 points as rising rates lift bank stocks
Bank stocks gained as the 10-year Treasury note yield climbed to 3.11 percent, near its highest level of the year. The rise in yields comes as the Federal Reserve begins its two-day monetary policy gathering today, with analysts expecting the U.S. Federal Reserve to announce a quarter-point rate hike when it concludes its meeting tomorrow.
Summary
Financial markets are braced for a hawkish statement from the Fed as it pushes financial markets to expect more rate hikes in 2019. Will higher rates be a windfall for the financial sector?
Comment
Treasury yields are threatening range highs, financial conditions are steady as can be, and the yield curve has stopped flattening for now. Some investors appear to think it’s time to dip their portfolios back into the financial sector. The chart below shows net flows for U.S. financial sector ETFs turned positive in September for the first time since March.
The stagnant investor interest in financials contributed to the sector’s dismal underperformance versus the broad S&P 500. Only neck and neck early in the second quarter, financials have fallen behind by 8% in the last six months.
There are developing reasons for optimism about the U.S. financial sector. We estimate fair values for S&P 500 industry total return indices. The chart below shows the distance (actual – estimate) in standard deviations to our fair value estimate. Banks and diversified financials are both slightly cheap to fair value. The insurance index looks vulnerable, having just reached 2 standard deviations above fair value.
Looking at the contributions of the variables to our fair value estimate over time helps illustrate how opposing forces have dissipated in recent weeks and what might drive prices going forward. Since the three industries show very similar contribution profiles, the chart shows the average contribution across all three industry groups (banks, diversified financials, insurance).
Two typically opposing influences for the financial sector are the U.S. dollar (light blue) and the relative performance of developed versus emerging market equities (light green). These forces often offset to varying degrees. Dollar strength is typically a bearish influence for U.S. equities, but related inflows associated with developed market equity outperformance are a bullish influence. These forces have worked against each other since mid-2017 but have diminished in recent weeks as the dollar stabilized.
The financial sector might be ready to get back to basics as these influences recede. Higher global interest rates (orange) and a break in the curve flattening (yellow) are two bullish influences ready to step into the void. The largest threat aside from lingering dollar strength is the elevated policy uncertainty reflected in Google search trends.