GOLDMAN SACHS: This is the perfect environment for bank stocks - here are 7 reasons why they're set to spring higher

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GOLDMAN SACHS: This is the perfect environment for bank stocks - here are 7 reasons why they're set to spring higher

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  • Goldman Sachs says we're currently in a great environment for bank stocks, despite mounting investor concern that we're headed for a major economic downturn.
  • The firm argues these concerns are overblown, and provides seven reasons why bank stocks are a good buy right now.

When it comes to picking stock sectors, financials are about as good as it gets right now, says Goldman Sachs.

The view may come as a surprise to market participants who are bracing themselves for an economic slowdown - or even a recession - but the disparity in outlook makes sense when you consider Goldman's comparatively rosy outlook.

The firm sees the ongoing nine-year period of expansion continuing for several more years. It says there's only a meager 5% chance of a recession in the next four quarters, and a 34% probability one transpires in the next three years.

Assuming the economy is safe over that period, what does it all mean for financial stocks? Goldman argues the industry is perfectly positioned, at least according to one indicator linked to the Institute for Supply Management (ISM)'s quarterly manufacturing report.

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Goldman notes that financials have historically been the best-performing sector during periods in which ISM manufacturing is declining from a peak, but still above the 50 threshold that indicates economic expansion. Call it a sweet spot of sorts.

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Goldman Sachs

But that's not all. Goldman has gone as far as to identify what it sees as the seven main reasons financials will outperform going forward. All quoted comments are from the firm's chief US equity strategist, David Kostin.

1) Rising interest rates - "Financials typically outperform when 10-year Treasury yields rise, but lag when the yield curve flattens. However, a sharp divergence has occurred as the recent back-up in Treasury yield has corresponded with sector underperformance."

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Goldman Sachs

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2) Increased capital return - By late June, the Fed will give its opinions on the Comprehensive Capital Analysis and Review (CCAR) plans proposed by banks.

"Last year, the government approved a 43% jump in capital returned to shareholders via buybacks and dividends," said Goldman. "Our Banks analyst Richard Ramsden expects the Fed will authorize a 16% rise in payouts for large cap banks during the 12 months ending June 2019."

3) Further deregulation - "Proposed amendments to the CCAR rules that would take effect next year would increase balance sheet capacity and give boards more control over the use of their capital."

4) Strong M&A advisory fees - "In the past two weeks, deals totaling $150 billion were announced, lifting YTD growth to +100% vs. the same period in 2017."

5) Net interest margin (NIM) expansion - "As the long end of the yield curve rises, benefits accrue to banks through higher investment and loan yields."

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6) Loan growth - Goldman notes that this is the primary source of investor pushback when it comes to its overweight recommendation, but it sees two elements working in its favor.

"Small banks have registered a 7.7% jump in loan growth boosting the overall bank loan growth to 4.6%. Furthermore, the drivers of loan growth are trending in a positive direction (increased capex plans, increased M&A, and low cash balances.)"

7) Attractive valuation and growth - "The Financials sector trades at an above average relative valuation discount vs. the S&P 500 across several metrics. However, Financials operate with much lower leverage than in the past. Consequently, the median return on tangible equity (ROTE) for the sector equals just 13%."

Get the latest Goldman Sachs stock price here.

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