Note: This is just one in a series of articles talking about my top picks for 2020. I encourage you to check out my other top picks under the "Trade Ideas" tab and look for the "Top ETF Picks For 2020" heading!
For several years, the financial sector has struggled with profitability as the flat yield curve has put a lot of pressure on operating margins. In response, banks have been instituting cost cutting measures, including job cuts, and focusing on other business units, such as investment banking and trading, to help make up the difference.
That environment may finally be coming to a close. Banks have been doing a relatively good job of building leaner operations in order to stay viable during this period of ultra-low interest rates and an inverted yield curve.
But now, the interest rate environment is starting to normalize once again. The 10Y-3M Treasury yield spread, which had dipped to as low as -0.52% at the end of August, is back to 0.31%. The 1-year T-bill still yields less than the 3-month, but everything else is back where it should be once again.
We can thank solid, if not strong, GDP growth, low unemployment and a Fed willing to support this marketplace for improving investor optimism and raising expectations for stronger loan growth going forward.
The yield curve will be the most important factor to watch in the coming year. Wider spreads obviously make it easier to generate greater net interest income but a normalized curve is also a signal of healthy demand for borrowing.
Q4 GDP growth expectations are somewhat mixed but I think we're looking at the possibility of recession in 2021 at the earliest. Year-over-year growth of 2% isn't exactly robust, but it also appears to be at low risk of slipping towards 0% over the next few quarters.
The consumer is what has been driving this growth in spite of weak industrial production and a contracting manufacturing sector. As long as consumers keep spending, there's good reason to believe that the economic expansion can continue.
With the Fed willing to let the inflation rate move above its 2% target in order to “make up” for past low inflation, the long-end of the yield curve could be heading higher yet making banks even more attractive.
We’re already starting to see this story play out as banks have outperformed the S&P 500 by about 6% over the past 3-4 months. The yield curve will be key. If it remains normalized and the 10Y-3M spread continues to expand, financials could be the biggest sector outperformer in 2020.
If you liked this article, please click the LIKE button or share it on Twitter, Facebook, etc. using the buttons below.
Feel free to leave any comments, questions, or thoughts on the ideas presented here (and sign-up if you haven't already).
Follow me and receive periodic notifications when I post here by clicking the FOLLOW button at the top of the page!