This article was originally produced in conjunction with the AIC for their News and Insights.
Some information contained herein has been obtained from third party sources and has not been independently verified by Polar Capital. Neither Polar Capital nor any other party involved makes any express or implied warranties or representations.
Donald Trump’s first few weeks as President of the United States has brought daily reminders that he will be doing things a little differently. In the lead up to the election what was of most interest to us was the potential impact he would have on US financials, should he win. In his first term, his focus on deregulation, tax cuts and focus on economic growth was a good indicator for what to expect the second time around, albeit US equities were on much lower valuations in 2016 versus now.
The US economy showed robust growth in 2024, with macroeconomic indicators exceeding expectations. The Federal Reserve's so far successful soft landing for the economy was well-received by equity markets, as evidenced by the S&P 500 Index's impressive 25.0% rise last year. Against that background US financials returned 31.7% as they were seen as one of the biggest beneficiaries of the receding worries about a US recession.
Trump 2.0 has hit the ground running, already replacing the leadership at two key regulatory bodies, the Federal Trade Commission and the Consumer Financial Protection Bureau. His administration has also opposed the Federal Reserve’s efforts to increase capital requirements yet further for banks under the Basel III proposal, and there have been discussions around downsizing or even eliminating certain agencies to reduce overlapping regulatory functions and streamlining oversight.
With Trump's anticipated reduction in corporate taxes as well as regulatory burdens, US financials, being more domestically focused, are poised to benefit and the expected moderation in capital requirements increases for banks. All of this plus the potential rise in M&A activity in our view present attractive investment opportunities. Consequently, we increased our holdings in several US financial stocks including holdings in US banks, reallocating from other portfolio areas.
Trump's policies are seen as inflationary, as reflected in the bond market's reaction, with 10-year US government bond yields at around 4.5%, having touched 3.6% in September. The resulting steepening of the yield curve, where the spread between long and short-term interest rates widens, is therefore advantageous where banks borrow at short-term rates and lend at long-term rates, increasing net interest income.
As expected, there has been some concern regarding Trump’s implementation of tariffs but, in our opinion, the most affected will be emerging markets, in which we are underweight, rather than the impact being felt directly on the financials sector. While it will take time for these recently announced tariffs to be fleshed out, from a financials sector point of view, we currently don’t see a big risk.
While the expectation of lower regulatory pressures on banks is positive, the outlook for the US economy, which drives loan demand and credit losses, will have a more substantial impact on the sector's long-term performance. Although the sector's valuation is no longer anomalously cheap, it remains at a deep discount to the wider equity market and we believe presents a compelling investment opportunity.
