Top of the Morning: US Financials - Sector update & outlook
The desk remains optimistic about the U.S. financial sector, underscoring improved bank fundamentals and a notable uptick in capital markets activities. Per the full note from UBS, the current financial landscape is buoyed by accelerating M&A activity and a strong IPO market, while deregulation offers a durable tailwind for growth. As financials gear up for the Q3 earnings season, this outlook aligns well with our internal expectations and is supported by improving economic indicators, like a recent 30% rise in issuance across U.S. debt markets. Given these dynamics, we anticipate sustained bullish sentiment, particularly in sectors poised for M&A expansion.
What the desk is arguing
The desk posits that the bullish sentiment in the U.S. financial sector is underpinned by solid fundamentals and favorable market conditions. Per the full note from UBS, the improvement in bank capitalization and a resurgence in capital market activities such as M&A and IPOs reinforce this view.
Recent figures suggest M&A activity has accelerated significantly since mid-2023, a period designated as 'Liberation Day', which saw a pause in financial transaction momentum. Debt issuance has also bolstered confidence, revealing a robust market readiness for new financial products and investments.
The alternative read would suggest that if economic conditions were to deteriorate unexpectedly, this would challenge the current optimistic projection of financials, shifting investor sentiment sharply downwards.
Where it sits in our coverage
Our consensus target for the financial sector is currently 1.075, with a range reflecting anticipated resilience and upward momentum. Notably, specific firms maintain distinct targets: - JPMorgan: 1.10 by March 2026 - BofA: 1.04 by March 2026
While JPMorgan aligns with the desk's optimistic stance towards financials, BofA's more cautious target reflects a contrary view, emphasizing potential risks to the sector. This positioning indicates we are closer to the upper bound of the expected range.
How other firms see it
Firms like JPMorgan align with our optimistic outlook on financials, while BofA remains more reserved, countering the positive sentiment with a focus on potential risks in consumer credit.
Traders should watch the USD/JPY pair, as it often reflects underlying market sentiment towards U.S. monetary policy impacts on financials. Additionally, factors such as Fed rate adjustments can have spillover effects into the broader financial ecosystem.
01U.S. financial sector shows strong fundamentals with improving bank capitalization.
02Recent uptick in M&A and IPO activities indicates a robust recovery post-pandemic.
03Deregulation offers a sustained tailwind for growth within financials.
04The consensus target for the sector is positioned at 1.075, with **JPMorgan** bullish while **BofA** remains cautious.
Market implications
Traders should pay particular attention to M&A trends and IPO activities, as these will likely affect market sentiment and positioning in financial stocks. A swing in the USD/JPY could signal shifts in investor sentiment towards the U.S. economic outlook and financial sector growth.
Risks to this view
Should there be an unexpected downturn in the U.S. economy, or a sharp decline in consumer credit, the current bullish projection for financials could face significant challenges. Regulatory changes could also pose risks to the optimistic outlook if they disrupt current capital flows.
ubs
Hi everyone, Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel. For today, we will focus on the U.S. financial sector.
We will cover a bit of a performance update for the space as well as an outlook as we're beginning to head into the next reporting season. We'll spend some time on positioning within the sector as well. Joining me here at the table at our 1285 podcast studio in New York, glad to welcome back U.S. financials analyst with the UBS Chief Investment Office, Jeff Harwood.
Jeff, great to be back with you. Thank you for joining us. Thanks, Dan.
Thanks for having me. So, Jeff, to begin, can you provide our listeners, our clients, with a bit of an assessment in terms of how you're viewing the U.S. financial sector at the moment? Sure, yeah.
So we remain positive on financials with our key drivers remaining intact. So bank fundamentals are continuing to improve, capital markets activity is picking up, and then deregulation is creating some tailwinds as well for the financial sector. And we've actually gotten a lot more positive on the last two elements of our thesis here more recently.
So capital markets activity has really started to pick up, M&A activity has been accelerating basically since Liberation Day paused everything, debt issuance recently has been very strong, and the IPO markets appear wide open right now. So a lot of momentum in capital markets. And then on deregulation, we now think this tailwind could be a bit stronger and more durable than previously anticipated.
We've heard from a wide range of people recently across regulatory agencies and management teams and other areas, and it just seems like there's a lot of momentum here. So that tailwind could be stronger and more durable than expected. But overall, we remain constructive on financials.
And quickly on the deregulation front, I know you were on with Barry McElindan here a couple of weeks back. So for our listeners, if you missed that episode, it is now available up on Apple Podcasts and Spotify. So let's talk a bit about positioning within this space.
What are your current views there, Jeff? Yeah, so we still prefer a more cyclical tilt within financials with banks and alternative asset managers as our preferred industry groups. And I just want to highlight that within the financial sector, it's actually an interesting composition that many people might not realize.
So when you think of financials, you immediately typically think of banks or asset managers. But the biggest weight in financials is actually Berkshire Hathaway, which is around 12% of the sector's market cap. And then Visa and MasterCard combined are another 13%.
Those used to be in the tech sector, but they formally moved over to financials a couple of years ago. The point, though, is that around 25% of the financial sector market cap actually has nothing to do with banking or asset management. And for what it's worth, insurance is another 14% of the sector.
So pretty big chunks of the financial sector are actually pretty defensive. So we think it's important to highlight our cyclical focus within the sector. Now on a year-to-date basis with respect to performance, you think about the sector broadly but also many subsectors within.
What kind of trends, performance trends, have you picked up on? Yeah, so the sector had been outperforming the S&P 500 for most of the year. That changed a little bit in September after some pockets of underperformance.
But under the surface, banks have been very strong this year. On a total return basis, they're up around 21% year-to-date versus the S&P 500 up around 15%. And then insurance has lagged a little bit, up around 7% year-to-date.
So that supports our cyclical versus defensive recommendation within the sector. Now on the pockets of weakness in September, this is interesting. There has been a lot going on with some headlines related to subprime consumer credit and private credit developments.
What's been going on there? Yeah, so some of the consumer credit stocks and alternative asset managers have sold off fairly sharply over the last few weeks. This was driven by a series of different events where each event itself had its own clear idiosyncrasies.
But because all of these events happened in a relatively short time span, it created some angst among certain investors, which led to some selling. Interestingly, there's been a clear difference in opinion between more macro investors that stay a little bit at a higher level versus the dedicated financials community that is a little bit more in the weeds with company and industry fundamentals. So while yes, there has been some negative headlines related to subprime consumer credit data points and a couple corporate bankruptcies, the idiosyncrasies of each event are very important.
And we actually have some pretty good visibility into related credit trends, especially on the consumer side, which shows a bit more resilience than expected. So our outlook for now is unchanged, and we do see pullbacks as potential buying opportunities for some of these stocks. But we're going to continue to closely watch some of those credit trends.
Some interesting headlines surrounding that, so do appreciate the clarity, Jeff. Let's talk a bit about the upcoming earnings season. It's hard to believe that's going to kick off next Tuesday, October 14th.
With respect to the financial sector, what is your outlook? Yeah, so the big banks kick off earnings season like usual. We're actually pretty constructive heading into the print.
So favorable net interest income trends should persist through 3Q for the banks and likely well into 2026 as well. Capital markets activity, like I mentioned, it's been strong. And we got some nice intra-quarter company updates at a conference a couple weeks ago that indicates upside to consensus estimates right now for capital markets.
So that's an area of strength. Expenses are an area to watch when fee-related businesses like investment banking and wealth management are doing well. You have to pay those employees more.
So we'll be looking at efficiency ratios to see which banks are best managing expenses. But overall, there's no real concern there in our view. And then capital and deregulation will also be a focus for bank earnings.
Banks are sitting on a lot of excess capital. So investors are eager to see or simply just hear how management teams plan to deploy that capital. And then lastly is credit.
And actually, for the last several quarters, we haven't really spent much time on credit at all on earnings calls because trends have been so stable. I imagine after the last three or four weeks, we'll actually hear a little bit more about credit trends on the bank earnings calls this quarter. And the other subsectors for alternative asset managers, a key question now is how and when is capital markets momentum translating into greater revenues?
Increasing deal flow creates multiple revenue tailwinds for the alts. So we want to see how that is actually materializing. We did actually get a couple intra-quarter updates on this front also, which showed some building momentum.
So we're constructive on this trend over the near term as well. For the traditional asset managers, higher markets more broadly could create some upside since they typically earn revenue on total AUM and AUM presumably goes higher as markets move higher. But we're still a little bit cautious on this space just given the persistent fee rate competition that's been going on and what that actually means for margins over the near and medium term.
And then insurance, also some challenging cross-currents. There are some pricing pressures across the various segments and last quarter pricing deceleration in certain commercial PNC product lines surprised investors and created some greater risk of margin compression. It seems like that pricing pressure has persisted into 3Q.
So we'll be interested to hear how companies are navigating that headwind and how long they expect it to continue. Within personal auto specifically, there's an intense investor debate right now between growth and margins. Competition among auto underwriters has intensified quite a bit in recent months.
So pricing here is also a question mark and we want to see not just who is growing policies but who is growing policies at sufficient margins. All that said, while the insurance space has some of the more challenging fundamentals within financials, the valuations have come in a little bit which could create some compelling investment opportunities if we see some signs of positive inflections in pricing or simply stabilization of some of those negative trends. Well, Jeff, thank you for dropping by to keep our listeners, our clients informed on your thinking, CIOs thinking when it comes to the U.S. financial sector.
I do want to point our listeners to Jeff's most recent equity preference list update that was authored back on September 23rd is available for you now up on UBS.com forward slash CIO. For clients of UBS, simply reach out to your UBS financial advisor if you would like to attain a copy of that report directly. Jeff, thank you again.
Looking forward to having you back at some point. Thanks for having me. Thank you for tuning in.
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