Financial stocks were supposed to be one of the big winners in 2017, but instead ended up badly lagging the market for most of the year. Analysts, though, are willing to give the sector another shot heading into 2018.
With stronger economic prospects, higher interest rates and lowered regulatory barriers on the horizon, at least two analysts are telling clients to up their allocations to banks and other parts of the group. They also cite tax reform and additional consumer strength as reasons to be bullish.
The recommendations come as financials lately have caught fire. Thanks to a 15 percent rally since early September, the Financial Select Sector SPDR exchange-traded fund is now up 18 percent for the year, about in line with the S&P 500.
Even with the strong rally, Bernstein analyst Noah Weisberger said this is "a cycle with room to run." The firm has upgraded financials to overweight, a view shared by analysts at CFRA.
"Net-net, we believe a rising rate environment, firm economic backdrop, deregulation, upside from tax reform, underappreciated earnings growth and impending CapEx impulse bode well for financials," Weisberger said in a note to clients.
Though strong, the autumn rally in financials has been uneven.
Banks, as gauged by the SPDR S&P Bank ETF, are up only about half as much as the broader financial sector, though they've rallied nearly 20 percent since the same early September starting point. Insurers, per the SPDR S&P Insurance ETF, have gained nearly 13 percent for the year. By contrast, financial services, using the iShares U.S. Financial Services ETF, have outperformed both the sector and the market, with a gain of just over 20 percent for 2017.
Weisberger turned clients' attention to the consumer finance, regional banking and diversified banking spaces as those standing to benefit the most from the conditions ahead.
"Despite the recent rally, we still see pockets of opportunity, particularly in the context of a persistently strong economic backdrop," he wrote. "And from a fundamental perspective, we note price returns have not been commensurate with earnings growth revisions in certain sectors, even amidst generally reasonable valuations."
Tax reform, assuming Congress passes a measure similar to the proposals being bandied about, also is expected to boost the sector. Bernstein analyst Kevin St. Pierre said a reduction in the corporate income tax rate from the current 35 percent to the 20 percent outlined in the Republican-sponsored plan would boost bank earnings by about 15 percent in 2019 — 21 percent for consumer finance.