March 11, 2025

A global leader in sustainable and quantitative investing.

Financials – riding the wave or getting washed away?

Colin Graham - Co-Head of Sustainable Multi Asset Solutions
Patrick Lemmens - Portfolio Manager

Financial companies are set to benefit from a wave of tailwinds, though stock picking is essential to find the best opportunities, Robeco’s active investors say.

Summary

Banks have the second-best earnings growth behind Big Tech
Fintech and an M&A consolidation wave set to benefit the sector
Cuts to regulation and red tape likely to benefit the US vs. Europe

Banks have beaten the main benchmarks this year, with US financials becoming the second-best earners behind the Big Tech firms. And the best may be yet to come, as innovative financial technology continues to mold the future of finance, the US banking sector faces a string of mergers, and European financials begin to deliver positive performance, our multi-asset and fintech investment teams say.

“The financial sector is currently benefiting from several positive factors,” says Colin Graham, Head of Robeco Sustainable Multi-Asset strategies. “Interest rates and economic activity are expected to remain higher for longer, which supports the profitability of financial institutions.”

“US financials have been delivering earnings, and while they are behind Big Tech, they are still clearly ahead of the S&P 500. Not surprisingly, we have seen a significant rally in the debt and equity sectors over the last 12 months. One note of caution is that we think much of the good news is priced in, and so is no longer ‘cheap’ relative to history at an index level, though active management can still find the best picks within the sector and relative to others.”

“Looking forward, capital markets are becoming more active, with a strong pipeline of M&A deals and initial public offerings (IPOs), through deregulation promised in the US across industries and within the banking sector. Europe remains a laggard here and is unlikely to benefit from the relaxation of regulation, but the continent does have a tailwind of lower funding costs as the European Central Bank (ECB) cuts rates.”

financials-riding-the-wave-or-getting-washed-away-1.jpg
US financials are the second-best performers on earnings per share growth. Source: Robeco, UBS.

Cutting red tape
Much depends on regulation, which is expected to be slashed in the US but remain high in Europe, and the future path of interest rates that dictate net interest margins – the difference between the rates at which banks lend to borrowers and pay out to savers.

“We are seeing better-than-expected economic activity in Europe and China, so we need the US economy to slow, though the probability of recession remains low,” Graham says. “Slower US growth will allow interest rates to drift lower, supporting net interest margins – one of the key measures needed to support profitability.”

“Loan demand remains anaemic outside the consumer sector, with much of the demand fulfilled by private credit, which benefits from a lower regulatory burden. We should note that the higher-for-longer US rate outlook with rising lending standards supports more expensive financial debt securities such as AT1s and the contingent convertibles (CoCos).”

An M&A bonanza
One of the biggest tailwinds is the expected consolidation in the US banking sector, which has hundreds of small, regional banks whose business models have been disrupted by fintech firms, and who may be too small to survive without mergers.

“Since the US election, excitement in M&A teams is at fever pitch in anticipation of a much more permissive regulatory regime under Trump 2.0, with the financial sector in general, and global fintech in particular, likely to be in focus for dealmakers,” says Patrick Lemmens, Portfolio Manager of the Robeco Fintech and New World Financials strategies.

“Looking ahead, we see the pipeline for M&A deals and IPOs as significant tailwinds for overly fragmented US regional banks, and also for Chinese banking and property consolidation. While some politicians have voiced objections, the strong desire from the ECB to have more cross-border mergers should ultimately lead to M&A heating up and getting done in the European financials landscape.”

Targeting the underbanked
Another tailwind is the new business that could be gained bringing banking services to millions of people who don’t have bank accounts.

“While the use of environmental, social and governance (ESG) factors may be facing headwinds in the US, the social benefits of banking are undeniable, so financial inclusion and servicing the under-banked are trends that are here to stay,” Lemmens says.

“The emerging finance trend focuses on the growth of the global middle class, especially in emerging markets, where financial penetration is still low. On top of that, you have the digital finance trend where fintech companies offer smart digital solutions to customers with no bank account or who receive poor banking services.”

This can also be seen in the US, following a survey conducted by the Federal Deposit Insurance Corporation (FDIC) in 2023 to discover who holds no bank account (unbanked), or who owns an account but uses alternative financial services (underbanked). The results are shown in the table below:

financials-riding-the-wave-or-getting-washed-away-2.jpg

Taking an active approach
So, where to find the best picks? Here, targeted stock picking is essential as fintech continues to disrupt the system, while M&A offers opportunities and an aging population creates more demand for financial services in general, Lemmens says.

“The rapid pace of fintech evolution requires an active investment approach,” he says. “We prefer fintech companies operating from one technology platform, with superior software that means they can operate at much lower costs than rivals, and certainly cheaper than traditional banks.”

“Better and faster service helps to grow toward a significant customer base to whom you can offer an increasing number of products and services. Active investments in those kinds of winners should deliver the best stock returns in the longer term, as long as you buy growth at a reasonable price (GARP).”

“Stock selection is absolutely critical in our view, given the competition between the huge start-up ecosystem, existing players, and traditional financial sector incumbents attempting to defend old business models.”

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Global

markets

outlook

Financials

–

riding the wave or getting washed away?

March 2025

Source:

Robeco, Bloomberg. Note Returns in Euros

Assets that have had a strong trend took a pause

All market data to 28 February 2025 unless mentioned otherwise

General overview

February saw momentum take a breather as risks mount

For the shortest month of the year, February was action packed for

investors. Starting with tariffs and the ‘will they or won’t they be

implemented’ debate, the month ended with new highs for equity

markets on 19

February (MSCI World index USD), weaker growth, less

disinflation and the Magnificent Seven having the worst performance

month since December 2022. This led investors to a shift into more

defensive assets: sovereign bonds, gold and value stocks. US Treasury

yields dropped significantly, dragging down German Bunds marginally.

The debate over the impact of tariffs continued, with discussions on

whether they are inflationary or not. However, US inflation readings

began to tick up, raising concerns.

Source:

Robeco, as @ Feb 2025

Chinese monetary policy turns positive

All market data to 28 February 2025 unless mentioned otherwise

General overview

Searching for signals

The raised uncertainty and risks had investors searching for signals or

fundamentals to inform their decision making but generally finding little

inspiration. This led to positioning shifts, both reducing risks and profit

taking in large positions in crowded trades.

This environment provided Europe with a backdrop to outperform.

Following last month's theme, there was a glimmer of life in Chinese

equities. Under

-owned globally, Chinese stocks were boosted by several

policy measures announced over the last year, as corporate earnings

expectations stabilized after a long slide. This created conditions for a

13% rally in the Hang Seng index in February.

The surprise package was emerging market assets (both in debt and

equity), which consolidated a strong start to the year, supported by the

continued weakness in the trade

-weighted US dollar and ability or

willingness to stimulate monetary policy.

Riding the wave or getting washed away?

Chart 1: S&P 500 companies

earnings growth Q42024

Source: Robeco, UBS

Financials reflect if the economy is working

One of my mentors, a veteran emerging market equity investor in the

1990s, remarked that financials are the beating heart of the economy,

and you

cannot

allocate capital to a country if the financial sector is weak.

Right now, we should be confident about the US, European and Japanese

economies as banks have beaten the main benchmarks this year.

What has been the catalyst ?

US financials have again delivered the second

-best earnings behind the

Big Tech firms, and the best may be yet to come as innovative financial

technology continues to mould the future of finance. European financials

have begun to deliver positive performance, substantiating our central

scenarios for 2025.

Theme

of the month: Financials

All market data to 28 February 2025 unless mentioned otherwise

What else could maintain the financials’ positive outlook ?

We are seeing better

-than

-expected economic activity in Europe and China,

so even if the US economy is slowing, the probability of recession remains

low, and so the bedrock of earnings should remain solid. The top chart

shows that Eurozone bank funding rates are falling, easing pressure on

margins.

US deregulation is sowing the seeds

The Trump administration’s second order of priority after imposing tariffs is

to cut red tape and gut business prevention units (BPUs), implying

deregulation. Since the US election, excitement in M&A teams is at fever

pitch on anticipation of a much more permissive regulatory regime under

Trump 2.0, with the financial sector in general, and global fintech in

particular, likely to be in focus for dealmakers. The bottom chart shows that

M&A, IPOs and buy

-outs have room to increase given recent low activity.

An improving outlook for Europe and China economies

Chart 2: EU banks funding costs are falling, will credit demand pick up with economy?

Source: LSEG, Robeco

Theme

of the month: Financials

All market data to 28 February 2025 unless mentioned otherwise

Chart 3: M&A, IPO and buy

outs have had a barren patch

Source: Robeco

What about EU Banking Union in the Draghi report ?

While some politicians have voiced objections, the strong desire from the

ECB to have more cross

-border mergers should ultimately lead to M&A

heating up and getting done in the European financials landscape. We do

wonder what will happen given the initial grumblings from German

politicians are set to delay or even prevent the obvious banking union from

happening. The top chart shows that JPMorgan is almost as large as the top

10 banks in the EU put together.

The ‘S’ in ESG is still needed

While the use of ESG may be facing headwinds in the US, the social benefits

of banking are undeniable, so financial inclusion and servicing the under

banked are trends that are here to stay. The emerging finance trend focuses

on the growth of the global middle class, especially in emerging markets,

where financial penetration is still low. That said, the US has a significant

number of households who have no bank account (unbanked), or where

they have an account but use alternative financial services (underbanked).

The table shows the opportunity for more financial inclusion, especially with

fintech innovation.

The future could be bright for EU banks

Theme

of the month: Financials

All market data to 28 February 2025 unless mentioned otherwise

Table 1: US under and unbanked

Source: Federal Deposit Insurance Corporation (FDIC) 2023 report

US economy

Underbanked

Unbanked

% of households

14.2%

4.2%

No. of households

19.0 mln

5.6 mln

Chart 4: Market cap of largest banks

in the US

and EU at 7 March 2025

Source: Bloomberg, Robeco

A hyperactive US administration

We have to go back to Roosevelt in the 1930s for a comparable vigorous start to a

US presidency. In just over a month, we have so far seen the launch the DOGE

government efficiency program, rolling back environmental regulations to boost

energy production, efforts to reduce healthcare costs and cuts to Medicaid, a

rapprochement towards Russia in geopolitics, and last but not least, the start of a

second tariff war.

Trump’s tariff tango continues

The many twists and turns in Trump’s tariff tango have generated strong responses

in currency markets, especially those of Mexico and Canada, which face recessions

if the 25% tariffs on their exports are enacted. Yet, Trump delayed the tariffs on

these countries for a second time on 6 March. This could feed market sentiment

that Trump’s bark may be louder than his bite, though he did raise the pressure on

China with an additional 10%, raising the tariffs to 20%. Additionally, ships built or

flagged by China that moor in US ports will be levied a higher port fee. Freighter

MSC already indicated it will frequent fewer US ports to minimize fees. This new

strain to US supplies could become more visible in the next few months.

Economy

So much short

term noise, so much long

term signal

All market data to 28

February

2025 unless mentioned otherwise

Economy

Strong rally in the euro as German yields increased vs. US

All market data to 28

February 2024 unless mentioned otherwise

brittle expansion in manufacturing

is taking hold

The ISM manufacturing prices paid index already jumped in February,

showcasing frontloading by US importers to evade the tariff wave. The ISM

manufacturing leading indicator showed decelerating optimism among

purchasing managers but still pointed to expansion for the second month

in a row. The reciprocal tariffs, which are planned by Trump on 2 April, are

considered a key lever which could spur another bout of trade policy

uncertainty which is already at its highest level in 40 years

New German Chancellor Merz off to a flying start

The German elections of 23 February delivered a blow to Chancellor

Scholz’s SPD party with a victory for the center-

right CDU, led by Friedrich

Merz. The far

-right AFD won 20% of the votes, it’s highest showing ever.

Merz has mobilized the current parliament to change the constitution to

exempt defense and security outlays from fiscal spending limits and

thereby release the long

-standing German debt brake, a rule that limits

spending deficits to a maximum of 0.35% of GDP. Also, he plans a EUR 500

billion infrastructure fund. The AFD has filed a lawsuit at the German

Constitutional Court against relaxing the debt brake. Despite the

opposition by the far right, clearly the last month has seen momentous

change underway in the fiscal stance of the German government, which is

clearly reflected in the steep rise of the euro and a steepening of the

German Bund curve.

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