January was a brutal month for equity markets but nevertheless a positive one for the Trust. While financials are inescapably a value sector, there are many companies within it that are deemed ‘growth’ and consequently trade at high valuations, notably some of the faster growing asset management companies and data providers, which fell sharply. In due course, assuming a proposal put forward by MSCI and S&P goes ahead, payment companies will be added to that list when they move from the technology sector.

The sharp rotation out of growth stocks in January significantly benefited performance…as the sector is seen as the beneficiary of the pivot by central banks and higher bond yields

As a result, the sharp rotation out of growth stocks in January significantly benefited performance, in part as we had pulled back from some of the higher rated stocks within the sector but ultimately as the sector is seen as the beneficiary of the pivot by central banks and higher bond yields. Against this background, financials, as illustrated by our benchmark index, the MSCI ACWI Financials Index, rose by 2.3% while the MSCI ACWI Index fell by 4.2%, a level of outperformance that has only been matched in November 2020 on the back of the positive news about vaccines. The Trust’s net asset value rose 2.5%.

US and Europe

US financials rose 0.4% during the month, led by the banking sector, following a more hawkish stance by the Federal Reserve, which signalled the potential for a faster pace of interest rate hikes. US banks’ fourth quarter earnings generally beat expectations, with stronger net interest income on the back of stronger loan growth and lower provisioning partially offset by higher costs. JP Morgan and Goldman Sachs’ guidance for increased costs, the former driven primarily by a $3.5bn increase in its technology spend to $15bn for 2022, attracted significant attention and weighed on sentiment for the sector although most banks reiterated unchanged cost guidance.

European financials rose 3.1%, again led by bank stocks as investors reassessed the outlook for interest rates in the region. Despite ECB assurances that interest rates will remain at historic lows in 2022, markets are now pricing interest rate increases this year in response to persistently high inflation. As seen in the US, European banks’ results to date have generally come in ahead of expectations leading to further earnings upgrades (now at 61 weeks of consecutive upgrades, the longest stretch for 15 years). Conversely, European alternative asset managers suffered sharp falls in their share prices during the month.

Asia

Asian financials rose 2.1% in January, led by strength in China and Hong Kong supported by easing economic policy and certain measures to support the property sector. Results to date for our holdings in India have come in line with expectations and showed solid operating trends. For example, HDFC Bank reported a slight pick-up in loan growth, with loans growing 17% year-on-year, stable margins and asset quality with profitability remaining at high levels, while HDFC Corp also saw an increase in loan growth to 12% year-on-year driven by strong mortgage growth. Similarly, we have also seen an increase in loan growth in Indonesia at Bank Central Asia and Bank Rakyat Indonesia reflecting a recovery in broader activity levels supported by an easing in Covid restrictions.

Outlook

While underpinning the performance of the sector, the recent hawkish commentary and action of central banks has provided the catalyst for volatility in financial markets. In total, 17 central banks raised interest rates during the month, taking the total number of interest rates rises over the past three months to 55, versus the comparative period a year earlier of five. Indeed, markets currently expect the Canadian central bank, the Fed and the Bank of England to all raise interest rates at least five times during the year, with even the European Central Bank expected to undertake at least two hikes.

Against this background, one of the countervailing views on the outlook for financial markets is that the Fed will be raising interest rates in an environment of weaker growth as the yield curve has flattened, with the Atlanta Fed first quarter GDP forecast barely in positive territory and consumer confidence having fallen sharply. Furthermore, rising commodity prices, with energy and agricultural prices hitting highs, and geopolitical risks rising provide a significant headwind for markets.

Nevertheless, growth in the short term will have been impacted by the latest COVID-19 variant and therefore we expect the outlook will improve. Equally, the latest US employment numbers suggest that underlying growth is stronger than that implied by the Atlanta Fed, as does the pick-up in US loan growth which, having been anaemic over the past two years, jumped to an 11% growth rate on an annualised basis at the end of 2021. Furthermore, with central banks having been behind the curve of the inflation debate and needing to raise interest rates, we still see a positive set-up for the sector.


As at 7 January 2022.