Ladies and gentlemen,
We noticed something very interesting occurring in the markets and, if it does work our way, it could take the lagging sector we have been investing in and turn it into leaders. As 2019 started and our call on higher interest rates ceased, the financial sector weakened immediately. This sector has lagged the market all year and interestingly, despite the cuts in interest rates, the financials have gained back what they lost and they appear poised to move higher.
This chart shows that even as interest rates and bond yields (white line) have fallen and banks have seen net interest margins decline, the stocks (financial index) have recovered their losses and look strong going into year-end.
This is potentially due to the strong consumer and economy.
Looking at the S&P TSX Financial index, we are inches from breaking out to all-time highs. The earnings are not expected to be weak to end in 2019, so we are optimistic that they may move higher.
When we look at the financials, the green line indicates the price to earnings over the last 5 years due to interest rate changes. As the graph shows, it is trading more than 30% below the high and at much lower valuations than one year ago. As such, we believe that they are potentially undervalued and close to a price breakout.
The US banks are also a hair away from breaking out to all-time highs.
If this does occur and the Financials do break out to new highs, we could see a shift in leadership in the markets from the Tech companies to the Financials. It is too early to tell, but this is good news if it does occur as investors are very worried about a potential recession and are shifting to defensive positions.
This is good market action and a possible signal that we may go higher over the short term. Remember, the fundamentals of Bank of America were very good and, at present, there isn’t a big reason for them to decline.
