It has been sometime since Zenolytics took a good look at financials. In fact, the last time a big call was made on the sector was February of last year, in a note titled Financials Are Setting Up To Lead The Markets Down.
Since that last piece was published, financials have gone exactly nowhere. Well, let's be accurate here: they have declined by 2.85% as judged by XLF since February of 2018, making an investment in financials over the past 17 or so months about as noteworthy as an investment in a jar of peanut butter.
The motionless nature of financials as an investment, however, is due for a rather abrupt change into the second half of the year as a number of factors are lining up in favor of the sector.
Lest we forget that during the better part of 2018 the entirety of the financial corporate management community was licking their proverbial chops while salivating in embroidered leather buckets at the prospect of higher interest rates juicing corporate margins. The whole of the financial community from large all the way down to miniature sized companies were positioning themselves for the prosperous road ahead. Then the fall/winter of 2018 hit.
The change in interest rates that is still with us to this day was dramatic in every way possible. From the manner in which the Fed pulled one of the biggest 180s in organized central bank history, to the way in which the long end of the curve is basically attempting to choke the Fed into submission, hoping to justify bond investors piling into assets that are yielding 2% in the face of an equity market in possession of an increasingly attractive earnings yield.
While the entirety of the financial community was wringing their hands in anticipation of the prosperity to come, those hopes fell completely flat. The story here, however, is not that dreams were dashed and financial companies were positioned incorrectly for what was to come. The story here is how well financials have held up in the face of a completely unexpected outcome.
In the midst of this comes news like what we received this past week. Major banks passed their stress tests, freeing up capital to pursue shareholder friendly endeavors, such as increasing dividends and buying back stock. And that's exactly what is happening. JP Morgan, Goldman Sachs, Bank of America and Citi to name a few all announced dividend increases and substantial stock buybacks.
In what is a sector that has already experienced compression in earnings multiples, the prospect of large buybacks only makes valuations of these companies that much more attractive. Additionally, dividend yields on financials are now above 3% putting them on par with utility names at half the valuation of utilities that are selling at an average of 21 times earnings, while financials are down near 11, on their way to 10 with the buybacks announced.
All of this is coming as the technical outlook for a majority of financial names look prepped for something substantial into the second half of the year. Whether the tailwinds that develop in the sector are purely valuation based or whether they are fundamentally motivated as the economy moves along at a faster pace than expected, with interest rising far higher than most anyone currently thinks, there is certainly some percolation occurring in price.
Financials as of this very moment are in the perfect position to lead the next leg of this bull market. While that leadership may not become apparent until past September, right now is the perfect time to begin accumulating major, minor and in between financial names in anticipation of what is to come.
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