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Financials: Down But Not Out

By Benjamin Shepherd on June 17, 2016

June has been a rough month for financial stocks. They took a pounding following a weak jobs report and dipped again this week after the Fed decided to stand pat on interest rates.

Weak employment means a weak economy, and a weak economy is an excuse for the Fed to keep rates low, which hurts financial stocks.

The May jobs report, released on June 3, showed the U.S. economy added just 38,000 jobs that month, well below the 158,000 expected. It also wasn’t anywhere close to the average 200,000 jobs the economy was adding in the three months prior to May. It was also the softest report since 2010, dimming any hopes of a June rate increase and pushing the financial sector down 1.75% in the course of a day.

The sector took another dive in the week before the June Federal Open Market Committee meeting, falling by more than 6%. Between the weak jobs report and the still looming Brexit referendum, there just wasn’t much chance that the data-driven Fed would rock the economic boat with a hike right now. Chairwoman Janet Yellen is nothing if not cautious.

All of that said, I would bet that a July rate move is pretty likely, if for no other reason than May jobs report was probably an anomaly. For one thing, there was a massive strike at Verizon, which would have coincided with the May jobs data being gathered. The Bureau of Labor Statistics itself called out the strike for having cost the information services sector 34,000 jobs in the month. That strike has ended, so they’ll be added back in for the June report.

Another point: the monthly jobs report is just a snapshot and doesn’t really start to become reliable until the data is revised in the following months. In fact, the report has a margin of error of plus or minus 100,000—talk about wiggle room.

I also think the report might be a one-off because of wage growth. Hourly earnings advanced $0.09 in April and another $0.05 in May, which you wouldn’t expect to see if hiring was dropping off so dramatically. It’s possible that hiring is dropping off because the skill sets of available workers don’t match what employers need, so those already working are getting a wage boost, but I don’t think that’s the case – at least not entirely. So I look for the June jobs report, which will be released in early July ahead of the next FOMC meeting, to be a bit rosier.

Assuming that’s the case and that Britain doesn’t vote to ditch the European Union in the referendum coming up Thursday, I wouldn’t be surprised to see a July rate hike.

That would be good news for financials, which have been languishing since the Fed’s one-and-done hike back in December.

At the time, the Fed was signaling there would likely be four rate increases this year, which we now know was a bit optimistic. Financial stocks would have been glad of it though, since higher interest rates increase margins at banks since they’d be able to charge higher rates on loans. Insurers would have also been far from heartbroken, since higher rates mean they make more on their “float,” the premium payments they hold in reserve to meet claims. That money is often held in a portfolio predominately made up of bonds and, as we all know, higher rates equal higher yields.

Almost every financial companies will benefit from higher rates. So if you’ve been getting frustrated with the performance of your financial stocks lately, don’t despair yet. They may yet get a boost.

 

 

 


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