2016 has continued to be a challenging year for the financial sector and its performance has lagged the S&P 500 most of the year. Profits at many financial companies continue to be pressured by low interest rates. After the rate hike at the end of 2015, the U.S. Federal Reserve was expected to raise rates up to four times over the course of 2016. That projection was pulled back to two earlier this year and now there might not be an interest rate increase before the end of the year. The Federal Reserve has maintained a cautious approach to raising interest rates as a result of increasing uncertainty surrounding global economic recovery. The Chicago Mercantile Exchange’s FedWatch Tool estimates a 48% chance the Federal Reserve raises interest rates 25 to 50 basis points at its last meeting of the year in December. Several overseas central banks, including the Bank of Japan, have kept negative interest rates in an attempt stimulate economic growth.
An increase in interest rates would lead to an increase net interest margin (NIM) and be a boon for profits at most financial companies. NIM is a measure of the difference between the interest income a financial company generates and the amount of interest paid out to its lenders. For interest rate sensitive banks like Bank of America (BAC), analysts estimate an increase of 100 basis points in the yield curve could increase profits by billions of dollars. For now, it’s hard to say if and when the Federal Reserve will increase rates and by how much.
With diminishing opportunities to deploy capital, many financial companies are choosing to return excess cash to shareholders through dividend increases and share buybacks. Wells Fargo (WFC), Goldman Sachs (GS), Citigroup (C), JP Morgan Chase (JPM), Bank of America (BAC), and Morgan Stanley (MS) all announced increased dividends and share buybacks in Q2. Depending on the number of shares repurchased in the last quarter, these companies could benefit from a minor boost to earnings per share (EPS).
Concerns Persist Across Europe
Analysts expect the U.K. decision to leave the European Union, also known as Brexit, to have systemic effects on economies and financial institutions across Europe and negatively impact the U.K.’s gross domestic product in future quarters. Companies with significant earnings denominated in European currencies will continue to experience currency exchange losses thanks to the strong U.S. dollar. 25% of Goldman Sachs’ and 15% of Morgan Stanley’s revenue comes from the Europe, Middle East, and Africa region.
Adapting to the Department of Labor Fiduciary Rule
The Department of Labor’s finalized fiduciary standard rule for financial advisors is disrupting the wealth management and insurance advisory operations at many financial companies. The new rule could minimize profit-making opportunities and add regulatory and compliance complexities to operations. Following the announcement of the rule, several foreign banks including Credit Suisse, Deutsche Bank, and Barclays decided to abandon their U.S. wealth management businesses.
Increased Government Scrutiny
Wells Fargo’s (WFC) account creation scandal has been dominating the news and CEO John Stumpf recently testified before a Senate committee investigating what led to the widespread fraud. The bank has fired 5,300 employees who opened more than 2 million accounts from 2011 to 2015 without customer approval to meet sales quotas. Wells Fargo agreed to pay $185 million in fines and penalties, but its problems could just be starting as several class-action lawsuits have been filed against the bank by customers and former employees. Shares of the bank have been dropped.
TD Ameritrade clients can get a visual view of the financial sector via a heat map in the thinkorswim® platform. See figure 1 below. The size of the square indicates the market cap of that company. With just a click, you can quickly access fundamentals, news, charts and more.