The financial sector has mostly fallen behind other U.S. market segments over the years, but 2018 may be the year that financials-related ETFs finally begin to outperform.
"Three drivers could potentially propel financials stocks higher in 2018. Earnings momentum coupled with deregulation, yield curve steepening, and the potential support of the value factor," Christopher Dhanraj, Director and Head of ETF Investment Strategy at iShares, said in a research note.
As the U.S. adopts corporate tax cuts and considers deregulation, the financial sector could enjoy new opportunities. Corporate tax cuts would naturally bolster earnings while potential financial sector reforms, namely removing rules imposed by Dodd-Frank, could further strength the banking sector. According to Bloomberg Intelligence, the Treasury Department's plans for deregulation could translate to a combined $124 billion of capital to return to shareholders.
Meanwhile, it is widely expected that President Donald Trump's Federal Reserve Chairman pick, Jerome Powell, will maintain the central banks current trajectory of monetary policy normalization. Yields on benchmark 10-year Treasury bonds have already hit nine-month highs and the spread between 2-year and 10-year yields have widened after the Bank of Japan announced it will cut its long-dated bond buying program and growing speculation of China's ongoing purchase of U.S. Treasuries. Nevertheless, as yields eventually rise, financial stocks could be in a position to benefit given the long-standing relationship between rates and banks' net interest margins.
Lastly, Dhanraj pointed out that the value theme has traditionally outperformed during periods of rising interest rates and benchmark bond rates, which may be favorable toward the still relatively cheap financial segment.
Investors who are interested in capitalizing on the potential strength of the financial sector ahead have a number of broad options to choose from. For instance, the iShares U.S. Financials ETF (IYF) provides broad financial sector exposure. The iShares U.S. Regional Banks ETF (IAT) may help investors capitalize on smaller banks that benefit more from deregulation and rising net interest margins. The iShares US Broker-Dealers & Securities Exchanges ETF (IAI) includes exposure to investment banks, brokerages and stock exchanges that may have more to gain from financial services reform. Lastly, the iShares US Insurance ETF (IAK) includes access to insurance companies that may find it easier to manage long-dated liabilities as rates normalize.
For more information on the financials sector, visit our financial category.