A Financial Sector Relative Value Trade

No sector has seen its performance turn for the better more than Financials in the last five months.

Financials started the year as the worst-performing sector, lagging the broader markets by over 8 percentage points through July 8, while the hunt for yield and falling interest rates pushed up Utilities and Telecom stocks to outperform the markets by almost 10 percentage points.

GICS Sector Performance of the S&P 500 Index (12/31/15−7/8/16)

GICS Sector 12-31-16 to 7-8-16

But over the last five months, as the 10-Year yield rose from its lows on July 8, this relationship changed and the Utilities sector now has the worst performance over the last five months while Financials are leading the way with rising yields.

GICS Sector Performance of the S&P 500 Index (7/8/16−12/7/16)

GICS Sector 7-8-2016 to 12-7-2016

The move has been so swift over the last five months that U.S. Financials have changed from being the worst sector to one outperforming the broader gains in the markets by over 10 percentage points.
Because the spike higher in interest rates manifested in strong performance, it may be time to re-evaluate sector rotation.

Where Is There Value in Financials?

There is one market where the Financials sector was down even more going into the bottom of rates and which has not made up all its losses, unlike in the U.S.: Japan.
Going into July, Japanese Financials lost cumulatively 40% from the start of the year.1 There was a remarkable turn, as investors become less bearish on the negative interest rate policy the Bank of Japan instituted in January and a broader pickup in global yields that feeds through to Japanese Financials. Increasingly, Japanese banks have been looking outside of Japan for growth, so a pickup in global yields supports Japanese banks.
Yet the Japanese Financials sector still has not crossed back into positive territory on the year and is still lagging the broader Japanese markets, unlike in the U.S.
WisdomTree Japan Hedged Financials Fund (DXJF) Performance (12/31/15−12/7/16)

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