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On 27 March we saw the worst price action for the sector since June as investors reacted to the failure of the healthcare bill. At first sight, the relevance of the healthcare bill to the banking sector might not be immediate. However, the failure to pass this first big test for the Trump administration caused the market to reassess the likelihood of Trump successfully enacting other measures, such as a reform of banking regulation and a stimulus package designed to boost the economy, prompt higher interest rates and thus boost bank profit margins.
The sector was a popular pick for 2017 among strategists when making their calls for the year, but by 19 March the closely-watched KBW sector was down for the year, while the SPDR financial sector ETF (XLF) was barely in positive territory.
Now it’s time to reassess and look at whether the sector is still interesting from a fundamental and technical standpoint. Last year it looked as if banks were heading for a tough year, with low rates and no sign of firm improvement in economic growth in the US. However, since then the price-to-book (P/B) ratio is around 40% higher, and while this is not excessively expensive, it does mean that the sector is not quite the bargain play of early 2016.
In addition, relative valuation (sector P/B divided by broader market P/B) for the sector is now at its highest level since early 2014. Some of the ‘valuation moat’ has been whittled away, but at least the sector is not as expensive as we saw during 2001-2007 and 2009-2013.
A bounce in the SPDR financial ETF (XLF) has seen the price close back above its 100-day simple moving average (SMA) at 2334, a bullish sign. The 3000 level, the low in December and January, has also held, so there is the possibility that we will see a push back to the 2528 level that marked the peak in February. A drop through 2300 would see a test of the rising trendline that has dominated since the June lows.
Longer-term, an improving economy and a gradual tightening from the Federal Reserve should help to boost bank margins and lending activity, while any regulatory reform and infrastructure stimulus should be seen as an additional positive catalyst for the XLF ETF.