Around this time last year, the outlook for U.S. banks was tenuous at best. The global economy was shutting down, and virtually no one understood the implications for credit, loans, liquidity, mortgages, and other avenues for banking revenue. Banks went into full defense mode.

For years, banks had been preparing for another crisis, and here it was. New regulations and Fed stress tests compelled banks to boost capital ratios and to make emergency plans. Many were ready for the crisis. But given the uncertainties of the pandemic, many banks went a step further and set aside tens of billions of dollars to boost capital reserves even more, anticipating another wave of loan losses and deteriorating credit conditions. Many banks feared the worst.

Fast forward to today, and the actual impact of the crisis was far less than anticipated. In fact, many banks have thrived over the last year, thanks in part to the U.S. housing boom, fiscal stimulus, and robust IPO activity. It is often said that good companies often emerge from a crisis even stronger than they were at the beginning, and I think big U.S. banks fit this profile.1

Below, I offer three reasons why I like banks in 2021, and how banks fit into our strategies and approach at Zacks Investment Management.

  1. The Yield Curve Favors Bank Profits

With yields on long-dated U.S. Treasuries ticking higher, the yield curve has been steepening recently – and that’s good news for banks.

A steepening yield curve generally means a more profitable lending environment for banks. Since banks borrow money at short-term interest rates (still close to zero) and loan money out at longer-term interest rates (which are currently rising), a steeper yield curve means bigger net interest margins on loan activity. As you can see in the chart below, the yield curve has been steepening since this time last year, and I think will steepen even further as the year progresses. Again, this trend implies an improving profit landscape for banks.

Source: Federal Reserve Bank of St. Louis2

  1. Steady IPO, Merger, and Trading Activity

Major banks can earn significant money from underwriting initial public offerings (IPOs), facilitating mergers, and fulfilling trading activity. I think all three will see continued strength in 2021.

On the IPO front, for example, the number of publicly traded companies is on the rise after a 20+ year slump. From 1997 to 2017, the number of listed companies dropped from 8,500 to 4,500, spurred by the tech bubble bursting. Last year saw a bit of a reversal – after modest upticks in 2018 and 2019, the number of listed companies surged by 200 in 2020, and I think we’ll see even bigger increases in 2021.

As it relates to mergers and trading activity, I think the liquidity factor will play a big role. I have written many times before about the extraordinary levels of monetary and fiscal stimulus, and the trillions of dollars sloshing around the capital markets. Banks should capitalize on this excess liquidity, in my view, via more trading and more deals.

  1. Higher Levels of Stock Buybacks

Since stock prices are established by supply and demand forces – and since stock buybacks act as a supply reducer – buybacks can be a tailwind for a stock. In the aftermath of the 2008 Global Financial Crisis, however, banks notably had restrictions placed on the amount of stock they could repurchase – if they could repurchase shares at all.

Those restrictions have eased over the years as banks recapitalized, and in the first quarter of 2021, regulators allowed banks to engage in stock buybacks. There are still leftover regulations on how much stock a bank can repurchase, but those restrictions are due to be lifted at the end of June. I expect to see higher levels of stock buybacks as a result.

So, what does this all mean for investors?

For one, I think having some diversified exposure to Financials is a good idea for equity investors in 2021. At Zacks Investment Management, we have a few strategies with different types of exposure to banks.

Our Preferred Strategy has a significant weighting in the financials’ sector, as banks are a primary issuer of preferred shares. With yield compression continuing in the banking sector as the yield curve steepens, we hold a positive outlook for many names in the Preferred space. Some 80% of our Preferred holdings are in some of the biggest and most robust U.S. banks (our weighting shifts over time).

Financials exposure is also evident in the Zacks Dividend Strategy. The Dividend Strategy starts with an investable universe of the Russell 1000 Value Index, and many of the biggest names in banking are categorized as value stocks. Our rigorous stock selection and screening process guide us to select what we see as the highest-quality banks relative to expected 2021 earnings, which establishes our Financials exposure each year.

Bottom Line for Investors

Some of the U.S.’s biggest banks have spent the last decade shoring up balance sheets and strengthening their capital position. In my view, a true test was presented last spring with the global economic shutdown, and the banking sector demonstrated its readiness. Capital and credit markets largely operated smoothly.

Now, with the world emerging from the pandemic and the U.S. economy poised for a strong growth year in 2021, I think banks are well-positioned to deliver strong earnings results and perhaps strong stock market gains as a result. Not all bank stocks are created equal, however, so investors need to use trusted and proven research and screening methods to establish banking exposure in portfolios. Zacks Investment Management can help.

 

Disclosure

1 Wall Street Journal. April 13, 2021. https://www.wsj.com/articles/banks-after-bracing-for-disaster-are-now-ready-for-a-boom-11618306200?mod=markets_lead_pos6

2 Fred Economic Data. April 19, 2021. https://fred.stlouisfed.org/series/T10Y2Y#0

DISCLOSURE

Past performance is no guarantee of future results. Inherent in any investment is the potential for loss.

Zacks Investment Management, Inc. is a wholly-owned subsidiary of Zacks Investment Research. Zacks Investment Management is an independent Registered Investment Advisory firm and acts as an investment manager for individuals and institutions. Zacks Investment Research is a provider of earnings data and other financial data to institutions and to individuals.

This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. Do not act or rely upon the information and advice given in this publication without seeking the services of competent and professional legal, tax, or accounting counsel. Publication and distribution of this article is not intended to create, and the information contained herein does not constitute, an attorney-client relationship. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of herein and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole.

Any projections, targets, or estimates in this report are forward looking statements and are based on the firm’s research, analysis, and assumptions. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and other sources may be required to make informed investment decisions based on your individual investment objectives and suitability specifications. All expressions of opinions are subject to change without notice. Clients should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed in this presentation.

Certain economic and market information contained herein has been obtained from published sources prepared by other parties. Zacks Investment Management does not assume any responsibility for the accuracy or completeness of such information. Further, no third party has assumed responsibility for independently verifying the information contained herein and accordingly no such persons make any representations with respect to the accuracy, completeness or reasonableness of the information provided herein. Unless otherwise indicated, market analysis and conclusions are based upon opinions or assumptions that Zacks Investment Management considers to be reasonable. Any investment inherently involves a high degree of risk, beyond any specific risks discussed herein.

The S&P 500 Index is a well-known, unmanaged index of the prices of 500 large-company common stocks, mainly blue-chip stocks, selected by Standard & Poor’s. The S&P 500 Index assumes reinvestment of dividends but does not reflect advisory fees. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor. An investor cannot invest directly in an index.

The Russell 1000 Growth Index is a well-known, unmanaged index of the prices of 1000 large-company growth common stocks selected by Russell. The Russell 1000 Growth Index assumes reinvestment of dividends but does not reflect advisory fees. An investor cannot invest directly in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.

Nasdaq Composite Index is the market capitalization-weighted index of over 3,300 common equities listed on the Nasdaq stock exchange. The types of securities in the index include American depositary receipts, common stocks, real estate investment trusts (REITs) and tracking stocks, as well as limited partnership interests. The index includes all Nasdaq-listed stocks that are not derivatives, preferred shares, funds, exchange-traded funds (ETFs) or debenture securities. An investor cannot invest directly in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.

The Dow Jones Industrial Average measures the daily stock market movements of 30 U.S. publicly-traded companies listed on the NASDAQ or the New York Stock Exchange (NYSE). The 30 publicly-owned companies are considered leaders in the United States economy. An investor cannot directly invest in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.

Returns for each strategy and the corresponding Morningstar Universe reflect the annualized returns for the periods indicated. The Morningstar Universes used for comparative analysis are constructed by Morningstar (median performance) and data is provided to Zacks by Zephyr Style Advisor. The percentile ranking for each Zacks Strategy is based on the gross comparison for Zacks Strategies vs. the indicated universe rounded up to the nearest whole percentile. Other managers included in universe by Morningstar may exhibit style drift when compared to Zacks Investment Management portfolio. Neither Zacks Investment Management nor Zacks Investment Research has any affiliation with Morningstar. Neither Zacks Investment Management nor Zacks Investment Research had any influence of the process Morningstar used to determine this ranking.

The Russell 1000 Value Index is a well-known, unmanaged index of the prices of 1000 large-company value common stocks selected by Russell. The Russell 1000 Value Index assumes reinvestment of dividends but does not reflect advisory fees. An investor cannot directly invest in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.