Shifting from growth to value, will tech give way to financials?

This article was produced in partnership with Brompton Funds.

The 1990s were broadly dominated by growth stocks that rode the rise of the Internet. Then the bubble burst and investors returned to value stocks for most of the 2000s, before low borrowing costs lit a new fire under growth stocks throughout the 2010s and up to last year.

Now, as higher interest rates limit the supply of capital, some analysts believe the trend for the next decade may be here.

“When interest rates were essentially at zero over the last decade, the broad theme was growth over value and we saw tech become a big outperformer,” says Mike Clare, Senior Vice President at Brompton Funds and portfolio manager of Brompton North American Financials Dividend ETF (BFIN).

“Now I think we've transitioned to an environment where value has started to outperform growth. And with interest rates moving higher, that's positive for financials.”

Speaking with Wealth Professional in an interview, Clare said financials stand to benefit from a number of conditions, including higher rates, robust cash flow, and attractive valuations that have been dragged down by recent bank failures.

“Investors tend to fight the last crisis,” he says. “And with strong memories of what happened in 2008, the collapse of Silicon Valley Bank and Credit Suisse saw financials sell off aggressively.”

“But if you step back and gain some perspective, banks and financials more broadly are much better positioned than they were in the financial crisis, so we believe current levels present a good buying opportunity for investors.”

Cash is king

Clare says you can’t compare the financial crisis of 2008 with the issues that brought down SVB and Credit Suisse.

“Then it was a balance sheet issue tied to subprime mortgages. This time, it’s an income statement issue.”

“Credit Suisse, for example, had a very strong balance sheet but their average return on equity over the last 10 years was less than zero,” Clare explains. When the crisis arrived, Credit Suisse didn’t have the profitability and cash flow to address their credit losses and deposit flight.

It was a similar situation with Silicon Valley Bank (SVB). They took in deposits throughout the tech boom and then parked the money in longer-term treasuries and agency securities. When interest rates went up, the value of those securities went down, and depositors began to notice and withdrew their money from the bank. Ultimately, the losses on SVB’s securities portfolio were bigger than their entire capital base, and regulators were forced to step in to protect the remaining depositors.

“This is not an issue for the broader banking sector,” Clare says. “There's no interconnectedness like we saw in 2008 when credit issues swept through the banking system. We don't have the same type of contagion today.”

Deposit beta

While rising interest rates proved to be a problem for banks like SVB, they have created a positive tailwind for the rest of the banking sector, particularly for well-managed banks.

One reason involves a concept called deposit beta, which measures a bank’s sensitivity to changes in interest rates. Clare says banks have been able to delay the payment of higher rates to their depositors.

“You'll see banks eventually start to flow through some higher rates to depositors, but it's manageable, and the underlying profitability of the banking system looks much better today than it did 10 to 15 years ago.”

Clare also says the collapse of SVB and Credit Suisse has benefitted other banks, as worried depositors shift their money to bigger institutions.

“When JPMorgan reported earnings recently, they were able to raise their net interest income guidance for the year,” Clare says. “That has helped quell some fears in the market, and I think the big banks in particular are poised to benefit from issues we're seeing across the sector.”

Insurers, Canadian banks, and other opportunities

Clare sees similar trends unfolding in Canada as well as further afield in the financial sector, in areas like insurance and payments.

“TD and Royal Bank stand out as we see them as the banks with the best deposit franchises in Canada,” he says. “Their deposits tend to be stickier, and they tend to have lower cost deposits than other banks that rely on wholesale funding or brokered deposits.”

Meanwhile, insurance companies, particularly life and property & casualty insurers, are benefiting from positive exposure to higher rates. They are repricing their assets faster than their liabilities, and that is having a positive impact on earnings.

Clare also highlights the insurance broker Arthur J. Gallagher & Co, as well as stock and derivative exchanges that have benefited from higher volatility in the market.

He adds that payments companies like Mastercard and Visa are benefitting from more cross-border transactions since the end of lockdowns and the rebound in travel.

Looking ahead

Clare likes what he sees for financials in the medium to longer term.

“Valuations across the space are attractive and the consumer seems to be in pretty good shape,” he says.

“We're still seeing spending out there, and inflation is starting to grind lower. Put all of that together and I think we see broad tailwinds for a shift from growth to value that could last for the better part of this decade.”

_{This article is for information purposes only and does not constitute an offer to sell or a solicitation to buy the securities referred to herein.  The opinions contained in this report are solely those of Brompton Funds Limited (“BFL”) and are subject to change without notice. BFL makes every effort to ensure that the information has been derived from sources believed to be reliable and accurate. However, BFL assumes no responsibility for any losses or damages, whether direct or indirect which arise from the use of this information. BFL is under no obligation to update the information contained herein. The information should not be regarded as a substitute for the exercise of your own judgment. Please read the prospectus before investing}