In 2016 and 2017, the financial sector was a standout. In 2018, not so much. In this Industry Focus: Financials clip, host Shannon Jones and Motley Fool contributor Matt Frankel discuss why the financials sector has been a market laggard in 2018 so far.
A full transcript follows the video.
This video was recorded on Sept. 10, 2018.
Shannon Jones: Before we dive into the specific stocks, we should probably start off by talking about the performance of the overall financials sector in 2018 so far. I mean, really, to be honest, it hasn't been that great, particularly when you consider the performance of 2016, 2017, and even things like tax reform and rising interest rates. What gives with the overall sector performance, Matt?
Matt Frankel: Just to run through the numbers really quick, year to date, financials are up less than 2%. The S&P, meanwhile, is up about 8%. But this follows, like you said, a couple of years of really, really strong performance. In 2017, financials barely outperformed the market, but the market was up by 20%, so that's pretty good. Financials were probably the biggest beneficiary of the presidential election in 2016, especially leading up to it. There was a period in early 2016 where the financials sector was looking pretty terrible. It went up from there. As soon as the election hit, financials just went on a tear.
To put that in perspective, even though they've been a big underperformer this year, and just barely matched the market last year, since the election, financials have outperformed the overall stock market by 7%. That's pretty good. The S&P is up by 35% since the election, financials are up by 42%. That's pretty good performance.
The catalysts that initially made the financials sector go up were the prospect of lower regulation, as the Republicans took power; tax reform, as Republicans took power, and as it actually happened; and the trend toward rising interest rates, which generally translates to higher profits for banks. As interest rates go up, bank loan rates tend to go up and deposit rates go up at a slower rate. It leads to better profit margins.
Those three catalysts are what originally pushed the sector up. Now that they've actually happened, we're kind of in a lull right now. Interest rates haven't really done the margin expansion that we've hoped for. If you've applied for a mortgage or a car loan lately, there really hasn't been a meaningful uptick in those loans, especially not comparable to how high the Federal Reserve has raised rates. The interest rate margin expansion has been somewhat disappointing. Tax reform already happened, so that was already priced in. The other one, regulation, we got some bank deregulation, but it didn't help the biggest names in the sector. It was more aimed toward small and medium-sized banks. When you're looking at the financial sector index, it's the big banks that largely drive that higher, and they weren't really a beneficiary of any regulatory reform we've seen so far, anyway.
Between those three things, that explains why, in 2016 to 2017, financials sector was the best performer in the market, and now are in a lull, after all of these things happened.
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