Ok, so it’s Sunday morning and writing about finance is always a tough sell on Sunday mornings.
You have to toe the line between putting something out that’s meaningful, but also easily digestible, because no one wants to think too hard.
On that score, I was saving Goldman’s latest “US Weekly Kickstart” piece, because while the point is simple, it’s also notable. That’s a rare combination of traits for analysis and as noted above, it’s pretty much the only kind of analysis that flies before noon on the last day of the weekend.
Right, so everyone was super excited about financials following Trump’s election – you know, “reflation,” “deregulation,” etc. etc.
That excitement has since been tempered, but it’s worth noting that between “hope” and the CCAR results (which green-lighted capital returns to shareholders), the financials have managed to kind of “Wile E. Coyote” it with respect to the curve, even as they haven’t generally performed well relative to everything else YTD:
This is particularly relevant today, because not everyone is sure that the handful of tech stocks that have shouldered a disproportionate share of the burden in terms of levitating benchmarks can continue to sustain the momentum. Atlas may be getting tired.
So that’s the backdrop for the following discussion from Goldman. Specifically, the bank takes a look at the correlation between tech and the financials and then endeavors to explain how both can do well going forward. Again, it’s not so much that there’s anything profound here, but rather that this is a debate that is worth keeping track of in the current environment.
Oh, and do note how the financials fared this week as investors digested earnings (spot the odd one out):
After many years of consistently high return correlation, the Financials and Information Technology sectors have posted significantly divergent performances twice during the past nine months. The three-month correlation of daily returns between Financials and Tech was actually slightly negative in February for the first time since at least 2001 (Exhibit 1). Financials surged by 17% between November and February while Information Technology and the overall S&P 500 both climbed by 8%. Investor realization that anticipated Trump administration policy proposals such as infrastructure spending and tax reform would be delayed or perhaps not implemented explains the shift in return correlations since the election.
After a brief return to normalcy in early 2Q, correlations between Tech and Financials have slumped again. The three-month correlation between Info Tech and Financials daily returns rebounded to 76% at the end of May. However, correlations have since fallen as Financials rallied by 7% following positive CCAR (“stress test”) results while Info Tech rose by just 3%.
Looking forward, we expect both sectors will outperform the S&P 500, although for different reasons. Put simply, growth will drive Technology share prices higher while change in growth will support the performance of Financials. The Tech sector will benefit from robust expected sales growth relative to the rest of the market while the prospect of higher interest rates and the ability to return capital to shareholders will benefit Financials. The positive fundamental trends in both sectors will likely result in a more normal positive correlation of returns between Financials and Info Tech.