Equity markets were slightly lower in January as an initial rally lost momentum on the back of concern about the slower than expected distribution of vaccines in Europe, as well as around the increased risk of transmission from variations of the virus in the UK, Brazil and South Africa. Against this background, the Trust’s net asset value fell by 1.6% while our benchmark index, the MSCI ACWI Financials Index, fell by 2.2%.
The results of the Senate run-off in Georgia giving the Democrats effective control of the Senate and House of Representatives raised expectations of additional stimulus leading to a jump in bond yields and inflation expectations. The steeper yield curve also provided support to bank stocks (prior to the broader market correction later in the month) with asset sensitive SMID-cap banks particularly strong, in particular Signature Bank and East West Bancorp
Conversely, our weakest performers were our holdings in Adyen, Mastercard and Arch Capital. Non-life insurance stocks were surprisingly weak in January despite fourth-quarter results for the most part being strong, with only a small number of exceptions, highlighting the improving pricing environment. As a result, we believe the weaker performance can be explained by investors rotating out of defensive sectors into more cyclical parts of the market.
US bank fourth quarter results came in better than expected largely due to the much lower loan loss provisions than expected, reflecting the resilience of the US economy albeit due to the huge fiscal and monetary stimulus in place to offset the impact of the pandemic. There was also a further fall in loans under deferral and trading revenues came in stronger than expected.
Not surprisingly loan balances have continued to decline, reflecting weak demand for credit and we would not expect it to pick up until the latter half of the year albeit a number of our SMID-cap banks continue to report extremely high levels of loan growth, including First Republic Bank, Signature Bank and SVB Financial Group. Positively, there are also signs of net interest margins plateauing supported by a reduction in excess liquidity and improving customer spreads.
Asian financials continued their outperformance in January driven by relative strength in both developed and emerging markets reflecting macro trends which continue to point towards an earlier and stronger recovery than in other regions. Looking back at the regional macro trends over the past month, what is striking is the strong recovery in exports with China, South Korea, Taiwan, Indonesia, Malaysia and Vietnam all showing double-digit rates of growth.
A key driver is IT and semiconductor exports (helping Taiwan in particular) but even south-east Asian markets, not driven by such exports, showed positive trends. Thailand’s exports showed the first positive figure in eight months, with the only laggard in the region being the Philippines. The strong trade picture helped to offset what remains a depressed domestic consumption picture in many economies in the region, but this is expected to recover as the year progresses.
The announcement of India’s budget was well received by markets and has provided support for our Indian holdings (our largest emerging market exposure) in early February. The budget included looser than expected fiscal deficit targets with a focus on infrastructure investment and privatisation. While we invest in the private sector banks in India, the announcement of a capital infusion into the state banks along with the creation of a ‘bad bank’ is positive for the financial sector overall given the drag on underlying economic growth from a weak state banking sector.
European financials were affected by concerns surrounding a resurgence in infection rates, renewed economic restrictions and a delayed rollout of the vaccine by the EU. With growth expectations for 2021 downgraded and relatively tight dividend restrictions limiting the capital return potential in the short term, European financials underperformed in the month. UBS’s share price bucked the trend with strong fourth quarter results due to strong net new money inflows, improved wealth management efficiency and resilient asset quality.
Over the past 30 years financials have without fail outperformed underlying equity markets from market lows whether it was the early 1990’s recession, the UK exiting the ERM, the Asian financial crisis and collapse of Long-Term Capital Management (LTCM), the TMT bubble, the global financial crisis, the eurozone crisis and the UK referendum. In the first year following the date markets hit a low the outperformance is fairly consistent and continues into the second year, albeit the dispersion of returns increases.
The only time the sector gave up some of its outperformance, was following the recovery in equity markets from the collapse of LTCM in October 1998 as the TMT bubble began to inflate through 1999. If we take the market low as 23 March last year, then financials underperformed to the end of January by 6.9%. Even if we take the performance from the day Pfizer announced the results of its vaccine trials, resulting in a sharp rotation back into financials, the sector has only outperformed by 6.5%.
This compares to historic outperformance of 19.3%, 22.5% and 25.6% over six months, one year and two years from the market lows listed above. This would suggest that if history is repeated, the sector offers much more relative upside. Logically, as it is a beneficiary of economies opening up, it makes sense that it should be outperforming. There have been no capital issues in the sector and with its earnings forecast to rise sharply as loan and insurance losses normalise over the next couple of years, we remain very positive on the outlook.