‘New world’ bodes well for financial equities

‘New world’ bodes well for financial equities

19-01-2017 | Visione

Since the election of Trump as the next US president, investors are starting to notice the financial sector’s low valuations and are allocating more money to it. Combining this with the fact that some segments of the financial sector are more resilient to (or even benefiting from) higher interest rates, we expect the sector to continue its strong performance in 2017.

  • Patrick  Lemmens
    Portfolio Manager

Speed read

  • Brexit and Trump black swans cost us performance in 2016
  • Blockchain is promising, but don’t get carried away by the hype
  • Best opportunities in emerging markets, Fintech and life insurers

Looking back at 2016

We started 2016 with the strong belief that interest rates were too low and at some point had to turn higher. We also believed that the financial sector was seriously lagging behind with its investments in IT and was not ready for a future with distributed ledger technology, Fintech competition and ever larger regulatory demands. In a world where growth was difficult to find, it made sense to look for growth in emerging markets financials.

The focus in our New World Financial Equities strategy was and continues to be on the aging finance trend (higher interest rates at some point and increasing need for savings), the digital finance trend (IT investments and Fintech growth) and the emerging finance trend (find emerging markets with a growing middle class and invest in the best positioned financials). Initially, interest rates moved down and into negative territory. Virtually everybody was convinced that rates would stay low forever. 2016 however turned out to be a year of very unexpected market movements, with Brexit and the election of Donald Trump as the most striking examples.

At the end of 2016, especially US banks but even European banks have priced in a lot of hope after the election of Trump, which is expected to lead to lower corporate tax rates, higher interest rates, better economic growth, less regulatory pressure and possibly lending growth. Still, lending growth and regulatory relief may turn out rather difficult to achieve.

While US and European banks have rallied hard, global life insures remain relatively cheap. They have only priced in part of the realized (!) move in higher bond yields. In the digital finance and emerging finance trend we have seen poor performance because of the Trump election as higher interest rates hurt IT stocks and stocks in emerging markets. Many Fintech stocks and other digital finance trend investments have lost (a significant part of) their growth premium. Most financials in the emerging finance trend are now cheap while the growth outlook has actually improved with the US economic outlook looking quite healthy.

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Financials are back

Since the election of Trump, investors are starting to notice the low valuations of the financial sector. They have been allocating more money to the sector, causing it to outperform the MSCI All Country World Financials index. Combining this with the fact that some segments of the financial sector are more resilient to (or even benefiting from) higher interest rates, we expect the sector to continue its strong performance in 2017.

We see further upside to long-term interest rates while beyond December’s Fed rate hike we are not automatically assuming two or three more. European politics and Europe’s banks continue to be a worry with quite a few elections taking place in 2017.

Analysts and investors are finally starting to look at 2017 with a bit more realism it seems. Some early doubts emerge whether Trump will be able to deliver on all the hopes of lending growth and deregulation. With a more realistic outlook and with long term interest rates clearly higher, attention has started to shift to (global) life insurers and emerging markets (banks). We also believe Fintech has become a lot more attractive and as investments will grow in 2017, we strongly believe investors will return to the Fintech space.

A word on blockchain

Just like in 2016, blockchain and Fintech will receive a lot of attention in 2017. Robeco New World Financials also aims to benefit from the growth in Fintech, currently investing between 15% and 20% in companies that officially are not part of the financial sector. More than one third of the portfolio is invested in the digital finance trend.

We are particularly careful not to get carried away by the hype, though. Just like some predicted in 2000 that the banking office was doomed (Euromoney: Death by a thousand clicks), many ‘experts’ are now lined up to make extraordinary predictions. Not every Fintech IPO is guaranteed to be a screaming success. Moreover, many legal, cultural and procedural obstacles have yet to be overcome before blockchain technology truly gets off the ground. Switching from legacy systems to a new technology involves costs and risks and blockchain still needs to prove itself in practical use cases. Also, business models and regulations need to be redefined. However, banks are indicating that 2017 will be a year of enhanced investment in technology. They recognize the need to do this and have more room to invest due to more favorable interest rate margins and cost cutting programs.

In the longer term, we expect blockchain to have a very important impact. Existing relevant parties will continue to play a role, however. Eventually, blockchain will allow us all to do business more cheaply, more quickly, more safely and more reliably.

Conclusion: recent developments confirm our conviction

We start 2017 with a portfolio that, in our view, strikes the right balance in a world of increasing interest rates and reasonable global economic growth, a world that offers solid growth prospects in emerging finance (especially emerging markets financials), digital finance (especially Fintech companies focused on banks, insurance and asset management IT) and aging finance (especially the life insurers and private equity companies).

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