It’s been a wild month for US banking stocks, which have rallied sharply since Donald Trump’s victory. So how can investors position themselves in the sector amid a potentially dramatic change in the business and regulatory environment?
After facing years of headwinds, US financials have been riding a wave of optimism. Since the election, the S&P 500 Banks Index has climbed by 17% through November 30.
Investors are beginning to believe that the new administration will usher in a new golden era for banking, which could foster robust earnings growth in the coming years. Several positive forces are likely to support the sector, including:
- Faster economic growth. The Republican sweep suggests that meaningful legislation is likely to be passed early in the Trump presidency. Lower corporate taxes and a fiscal spending boost are both on the agenda—and could fuel substantial economic growth. For investors, banks are pure plays on faster growth in America.
- Higher interest rates. Pivoting from monetary to fiscal stimulus could accelerate a rise in interest rates from historic lows. This increases the chances of a December fed funds rate hike kicking off a series of rate moves. Banks benefit most from rising rates, which increase their earnings from lending and investments.
- Regulatory relief. A Republican government is widely expected to reduce the regulatory burden that has evolved over the past eight years. The comprehensive Dodd-Frank rules probably won’t be quickly dissolved. But we expect Washington to gradually move toward pro-banking policies and away from the existing hostile environment. Over time, a friendlier regulatory environment can add to earnings leverage as legal and compliance costs fade. In addition, the extremely strict rules on capital allocation—which were already starting to ease—are likely to be eased further.
- Lower corporate tax rates. Trump has pledged to cut the corporate tax rate from 35% to about 20%–25%. This will buoy earnings per share (EPS) for US companies in general, with especially large benefits for companies that generate most of their profits domestically. Many multinationals, including technology, healthcare and consumer products companies, won’t be major beneficiaries because they generate a large proportion of profits abroad. Since most banks generate the bulk of their earnings at home, they should enjoy a big boost from lower tax rates.
Of course, there are risks on the horizon. Economic growth might not accelerate as expected and interest rates could decline again. Both scenarios would undermine the bullish outlook for banks.