5 Factors Driving Financial Stocks

Emma Wall: Hello, and welcome to Morningstar. I'm Emma Wall and I'm joined today by Jim Sinegal to talk about financial stocks.

Hi, Jim.

James Sinegal: Hi. Thanks for having me back.

Wall: Thank you for being here. So, you have five factors that influence financial stocks. What's the first of these?

Sinegal: Yeah. There are five questions on everyone's mind. The first question is, what is going on with interest rates. The Fed has started to move short-term rats up. A lot of people are looking at that as a panacea for financial stocks. We're a little more cautious. We think a lot of the factors that are keeping rates low, demographics, changes in technology, demand for borrowing within the U.S., are much slower to change than over the course of only a few months. So, we think it will be a long process of rate normalization.

Wall: And our colleague, Bob Johnson, in the U.S. thinks the same thing. He says interest rates, although they've signaled they'll come up a couple of times over the next year, actually it will be a slow and steady pace.

Sinegal: Yeah, that's exactly right. I think one of the lessons the Fed has taken from the Great Depression, from Japan is that the one thing you don't want to do is move too fast. And there are a lot of factors that still point to the need for very low rates. Though the unemployment rate is low, there are still a lot of people that have left the workforce. And those trends, the automation, offshoring of jobs, what's really taken away from labor, that takes a very long time to reverse and it's hard to see how that changes, to be honest, over any short period of time.

Wall: So, that's interest rates. What's the second factor?

Sinegal: The second factor is regulation. We have a new political regime and people are wondering how much that is going to help the banks. There's talk about tax cuts. There's talk about reversal of Dodd-Frank and here too, we think the market has gotten a little bit ahead of itself. If you look at Dodd-Frank, for example, we're seven years past the passage of the bill, only 80% of the rules are finalised.

So, reversing that is not going to be an overnight phenomenon. And the other thing people forget is the banking industry is very competitive. A lot of the benefits of things like lower taxes are going to end up going through to bank customers not necessarily bank shareholders.

Wall: I think that's very true on what you say about the market getting ahead of itself and that perhaps could be a query levelled at the whole of the S&P. I think, a lot of these benefits of Trump are already being baked into prices. So, maybe a bit of caution needs to be shown.

Sinegal: Yeah, that's exactly right. I think the one wild card is how much optimism changes. There's kind of a self-reinforcing cycle where people get excited about the economy, excited about the prospects for the U.S. They start to spend; they start to hire and then the economy does actually get better. I think that's the thing that's hardest to predict. How much of Trump's talk is going to actually influence people's behaviour.

Wall: And the third factor?

Sinegal: The third factor moving on to payments. We're seeing merchants get more heavily involved in the payments space. It's very expensive for retailers to accept electronic payments. So, merchants are really negotiating for lower prices and they are also trying to take back control of their customer relationships. For a long time, rewards have come from banks, from card issuers. Now, merchants are trying to get into the act. They are the ones that want to be handing out the rewards to their customers, not the banks.

Wall: So, interest rates, regulation, payments and number four?

Sinegal: Yeah. Fourth is another factor within payments, changes at the point of sale. We're seeing the point of sale move from card swipes to completely digital payments. People are paying more and more with their phone, although it's a slow process, more and more digitization.

So, what we're seeing is, companies that make the hardware that enable the card swipes, they are really in a tough position, because 5, 10 years from now no one is going to be swiping the cards, it's going to be 100% digital. The software companies are really going to benefit there.

Wall: We've certainly seen that in London getting on to the tube, the metro, the subway, people are increasingly just putting their iPhones down and that's what they are doing instead of having a piece of card.

Sinegal: Exactly. We've been waiting a long time for electronic payments to come. I think the whole 10 years I've been at Morningstar it's been something that's often at distance. Now, you're actually starting to see it occur in the wild.

Wall: And what's the fifth and final factor?

Sinegal: The fifth is valuation, probably the most important from our view. And as I pointed out, the market's valuation of financial companies has changed completely over the last three months. For most of the past few years, financial stocks were very cheap, but they have gone on a tear since the election. And now, a lot of financial stocks are looking expensive.

Wall: Jim, thank you very much.

Sinegal: Thanks for having me.

Wall: This is Emma Wall for Morningstar. Thank you for watching.