1. What is your investment outlook for global financial services in 2019?
Company fundamentals have improved significantly over the last few years. However financials have, to an extent, suffered from optimistic investor expectations at the start of the year, with quarterly results at times failing to live up to these expectations.
Sentiment in certain trades also appears extended, while segments of the market like European banks and certain emerging market stocks are now much cheaper, and could be poised for a rebound, given the right catalysts.
The global macroeconomic situation has also become more complex. US growth remains robust, while fiscal stimulus, deregulation and normalising Fed policy remain supportive for financials. Inflation and wage growth in the Eurozone are on a positive trend, ultimately encouraging further normalisation of monetary policy. However, Europe is more exposed than the US to the emerging market slowdown, while market concerns about the Italian political and economic situation are growing.
Emerging markets are suffering from Fed rate rises and the strong US dollar. This could change if China chooses to relent from its economic rebalancing efforts, given the depressive effects of the trade war with the US. Chinese stimulus measures would provide a significant tailwind for emerging market financials, and be positive for European ones too.
2. What do you think could most surprise investors next year?
A key question is whether the neutral Fed interest rate is as low as the market thinks.
A combination of several factors – fiscal stimulus, wage growth, relatively high savings rate – may have pushed the neutral rate higher. If so, rates may possibly come well above market expectations, which could lead to further US dollar strength and emerging market weakness. It is uncertain what effect this would have on the slope of the yield curve.
Emerging markets could, however, benefit from Chinese stimulus measures. We have already seen initiatives such as the newly-proposed auto sales tax cut, and prior measures such as VAT cuts, however a meaningful stimulus would probably require more. Should such stimulus materialise, an emerging market rebound is a possibility for next year; though this very much depends on Chinese policy and how much room the Fed has to raise rates.
We could see interest rate rises from the European Central Bank from 2H 2019, provided the trend towards higher inflation and wages in the Eurozone persists. This would be a significant catalyst for Eurozone banks. Much rides, though, on the market’s perception of the sustainability of Italy’s macroeconomic situation.
3. How do you plan to capture the best opportunities?
Despite the volatility and the disappointing performance of financials this year, there are many subsectors and companies with good earnings and strong balance sheets. Monetary policy is tightening, however is not yet restrictive, and owning quality businesses will be important for weathering further bouts of volatility.
Strength in the US economy, combined with further rate rises, will be helpful for US financials. The benefits to banks from deposit repricing are a little less now, however there is still some scope for (stickier) retail accounts to be a source of margin as interest rates rise. The portfolio also has exposure to some quality Eurozone banks that are still suffering from sentiment and that should stand to benefit from better fundamentals and eventual interest rate rises.
The portfolio also holds several promising insurance and reinsurance names. We have seen significant corporate activity in insurance this year, while there are also opportunities in currently niche but growing speciality markets, like cyber insurance. Certain emerging markets also present a structural insurance growth opportunity, given government incentives to increase coverage.
Exchanges will benefit from higher volatility, and the portfolio is overweight several names in this space. Opportunities in FinTech persist among large sector incumbents, as well as smaller payment firms.