There are several domestic economic factors investors are watching right now and trying to figure out which sectors and companies will benefit from the conditions. The Fed is in a rate-hiking mode right now and has announced a goal of three more rate increases in 2018. We have the new tax plan which is encouraging multinational corporations to repatriate assets being held overseas and one of the biggest uses for the repatriated assets is expected to be mergers and acquisitions.
Let’s start with the rising interest rate environment. When interest rates rise, the spread between the interest rate banks charge borrowers and the interest rate they pay on deposits becomes greater. This makes banks more profitable.
We could also see consumers acting on major purchases they have been putting off in order to get in while interest rates are still down. For a number of years, the Fed announced intentions to keep interest rates low and this allowed consumers to delay major purchases as there was no sense of urgency. Now that the Fed has announced intentions to raise rates, even though rates are still near historic lows, we could see consumers acting on buying wants rather than buying needs. This would increase the lending activity for banks while we could also see an increase in deposits as interest rates on deposit products rise as well.
Turning our attention to the new tax bill, one aspect I have been focusing on is the goal of having U.S. companies bring assets back to this country. The rate of repatriation and the uses of those assets are going to be instrumental in how successful the bill ends up being. Just this week I wrote about how the plans are becoming clearer. One use that companies listed in the top three was mergers and acquisitions. While these transactions aren’t typically good for the economy as a whole, M&A activity is good for the investment banking industry.
I have listed the five largest investment banks in the United States in the table below along with the fundamental ratings from Investor’s Business Daily. These companies stand to gain the most from an increase in M&A activity.
These five companies are also heavily involved in lending activity. What I noticed about these companies is that none of them have an SMR rating of an A. The SMR rating is a composite grade for the company’s sales growth, profit margin and return on equity. Most of them have respectable EPS ratings, meaning they are growing their earnings better than most companies. The sales, profit margins and ROE have been above average for JP Morgan Chase, Goldman Sachs and Morgan Stanley, but Bank of America and Citigroup have been average in these efficiency measures.
Given the potential for increasing margins via higher interest rates, the potential for increased lending activity, and the potential for increased M&A activity, I see the SMR ratings for these companies improving in the year ahead. If that is the case, the stocks of these companies should do well in 2018. The financial sector as a whole did outperform the overall market in 2017, but just by a few percentage points. Of the five companies, Bank of America performed the best last year with a gain of 35.7 percent and all but Goldman Sachs performed better than the S&P 500. Goldman gained 7.7 percent compared to the 19.4 percent the S&P gained last year. Citi, JP Morgan and Morgan Stanley all gained between 26.5 and 27 percent.
While asking for similar gains for a second straight year might be too much to ask, I can certainly see these five stocks as a whole outpacing the overall market again in ’18.