Time to take profits in Financials?

As Q3 earnings season gets underway, stocks in the Financials sector are in focus as they are typically among the first to report earnings. While history indicates companies are on average likely to beat Q3 estimates, our indicators, which have been supportive for Financials all year, are now starting to weaken and suggest it might be time to take profits in the sector and reallocate to other areas.

Sector Pair: Financials vs Health Care

In recent months, two of our strongest US sector allocation views have been to overweight Financials and underweight Health Care. A key feature of our sector work is that we often look at sector indicators on a “pairs” basis, i.e., the relative return, earnings momentum, and valuation of one sector versus another (as opposed to comparing sectors only to an overall benchmark like the S&P 500). This allows us to see the underlying relative performance drivers more clearly.

Banking sector facing good news/bad news from macro trends

Given the rebound in the Financials sector’s relative returns recently, and the broader increase in investor interest in Value after a long period of underperformance, it’s worth a look at some of the macro trends in the US banking sector to help identify trends that affect profitability. The data show both good news and bad news for the banking sector.

We first dig into the quarterly data on the US banking sector released by the Federal Deposit Insurance Corporation (FDIC), currently as of the end of Q3 (Sept. 30th, 2020), shown in the chart below. The top section shows the total assets of all FDIC-insured institutions in the US (about 5000 institutions), currently about $21 trillion.