IYF: Deposit Beta Kicks In, But Things Still Good For Insurance

seekingalpha06-06

iShares U.S. Financials ETF benefits from higher rates, but credit problems could have an impact on banking stocks if they came to pass.M&A activity is improving for full-service banks, while higher ...

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Pgiam/iStock via Getty Images The iShares U.S. Financials ETF (NYSEARCA:IYF) is a broad portfolio value-weighted in the subset of US financials, so banks and insurance companies. Deposit beta is kicking in for the banks, so there is no longer much incremental benefit from higher rates. M&A is improving for full-service banks. Higher rates mean better performance on reserve portfolios at insurance companies as well. In all, the higher rate environment is pretty good for the IYF ETF, to the extent that it doesn't start causing major credit problems, which would have a big impact on banking stocks. We are relatively confident in the US economy, and we also think that the idea that CPI going from 3.5% to 3.4% is \"cooling\" is a joke, especially when inflation expectations, which we'd say is the number one leading indicator and cause of inflation, is way above policy level and only slightly below current CPI figures. In all, we think financials remain a decent pick, but we might go further and just pick the insurance companies to avoid the direct consequences of credit issues with an ETF like the iShares U.S. Insurance ETF (IAK), which is the same conclusion we reached in our last coverage of IYF. IYF Breakdown The IYF ETF contains the typical large cap names that dominate US indices in general. Let's look a little closer at the sectoral exposures. Sectors (iShares.com) Financial services should include conglomerates like Berkshire (BRK.A), probably the rating agencies, brokerage companies, exchanges for derivatives and stocks and most likely the PE funds and asset management firms. Berkshire is basically an insurance exposure, though, due to the heavy tilt towards their insurance businesses. The banks are the full-service banks and the regional banks. Insurance is obviously the first line, with reinsurance companies in the ETF. In all, pretty uniform distribution, especially considering that BRK detail, between insurance, banks and financial services. Let's start with our view on rates because it is a common systemic factor for all the businesses, and a point that the market is getting repeatedly wrong. Inflation is not cooling just because it went down 10 bps. Inflation expectations are at 3% for the next 5 years according to the Michigan Survey. That along tells you that inflation above policy rates of 2% is not only persisting, but clearly well anchored. The Fed has so far failed in trying to get inflation down quickly, before anchoring happens, as was the hope of people like Federal Reserve Governor Michelle Bowman early in the inflation battle. The Fed might have been banking on the 2024 and 2025 maturity walls to help deliver the coup de grâce at current rates. We also saw this as potentially having a major effect. However, our house view has changed to incorporate the fact that refinancings are happening pretty quickly, with plenty of demand for corporate debt. We've been puzzled about the fact that credit spreads are at record lows despite what, we believe, are important outstanding questions around inflation and the health of the economy. Puzzled or not, it signals demand for corporate issues and means that even the high-yield issuers are smoothing out maturity profiles, and are probably not going to translate their issues into employment figures very rapidly, which would have a tractable impact on inflation as per the Phillips Curve. There is some reduction in availability of jobs, which signals slight cooling in the jobs market, but according to economic theory, and really to basic logic, that won't have an impact on inflation. As a consequence, with a smaller caveat for the maturity walls, and refinancings that are still happening at higher rates and putting some pressure on issuers, rates are more likely than not going to stay higher for longer. A recession for some other reasons would be needed to break the current pace that the wage-price wheel is spinning at. Bottom Line Higher rates have already hit peak benefits for banks. NIIs are about at peak, and in some cases, like at Bank of America (BAC), there clearly are declines coming. Loan growth is pretty modest nowadays, and fee income doesn't have much momentum either. The next phase may be credit issues, which we'd prefer to avoid. For insurance, higher for longer is great since it means that they can roll over their reserve portfolios, mostly composed of fixed income securities, at higher rates. Regarding financial services, the picture is much more mixed. For P/E, it's definitely not great, for asset management it's also not great since deposit rates and other easier savings alternatives become very formidable competitors. Also, AM had an issue with inflation in the fixed cost base that is hitting the stocks' performances. For brokerages, it's also not great since it keeps people on the sidelines. Rating agencies have more to do, though, lately, because of the major maturity walls in 2024 and 2025.  The clearest picture is for insurance. An insurance ETF would be preferable for us, or possibly some specific picks if we're more confident in insurance pricing in some markets but not others. Especially when P/Es are pretty similar between IAK and IYF, both at around 15x. Expense ratios are also the same at 0.4%.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.26.4","shortVersion":"4.26.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2441818897"}