Why Strong Earnings Could Spark a Financials Comeback

SPEAKER_1 (0:00)

Thanks, it's time for our ETF Watchlist. Joining me right now, Matt Bartolini, Global Head of Research Strategists at State Street Investment Management. So what is your look here as you think about the fourth quarter beginning, we're getting some of these earnings in, what's your macro look? We were just talking about some of these numbers being pretty good. I did think that even with JP Morgan's rare miss, they talked about an environment being robust and supportive.

Citi talked about the consumer business being strong overall. The feeling was that the economy was in a pretty decent spot from what we heard thus far. What do you say about the macro look? Are you worried about the future? Because that's something Citi noted too. What about the market conditions going forward?

Matt Bartolini (0:44)

Yeah, I mean, I think the banks reporting today are solidified somewhat of our views as well, in terms of what the macro landscape looks at. You do see still continued positive aggregate demand for the economy, and that should continue to support aggregate loan growth within these broader banks, but also continuing consumer spending. And now you have a period where you have rising or above market net interest margins for some of these larger banks, we've seen reported as well today. So the market sets up a sort of a conducive environment, even though some of the macro risks seem a little bit fragile, whether it's the war in Iran, upward pressure on inflation, and I guess still some higher policy rates. But for large scale financial institutions, that aggregate loan growth demand strengthen the consumer and the overall strength in the economy should continue to support some of those financial fundamental foundations.

SPEAKER_1 (1:33)

When we think about the XLF and the XLFI, the ETFs here surrounding these banks, is there something you want people to really know about these ETFs at this time, particularly as earnings are coming in and we're in this really headline driven market? Yeah.

Matt Bartolini (1:47)

Well, I think it's interesting though, even coming out of the Q2 earnings where there's really strong earnings momentum, fundamental momentum supporting financials, where you saw strong earnings surprise upside, revisions as well and full year 2026 revisions being guided upwards, is that financials largely from ETF perspective have been under owned. We've seen significant outflows within the broader financials ecosystem. We've also seen increase in implied volatility on the financial sector itself, and we've just seen a lack of interested buying demand ahead of another earnings period. So far, even though it's been short days, the earnings have come through and actually been quite strong, and have delivered on some of those foundations. So I think this is a little bit of an under owned sector leading into this quarter of earnings. I think we might see a little bit of a relief rally coming out of today, and of course, the ensuing days where more large financial institutions are reporting.

SPEAKER_1 (2:42)

Look, we're watching yields coming down a bit ahead of the CPI and PPI prints. You talked about different sectors, you talked also about technology earnings being in the lead, talked about healthcare presenting a constructive setup. But I wanted to get to a big picture topic, and that is midterm elections, where you said a divided government may actually limit sweeping legislation. I mean, that's lame duck basically, right? And that can sort of be good news for the market. What do you think about midterm elections and what are you watching for? We're anticipating for the market.

Matt Bartolini (3:14)

Well, I think in some cases, midterm elections in some sectors, the inaction will be the action point, and I think financials represents one of those. There's largely going to be a lot of inaction as relates to financial regulation and legislation in terms of net new. A lot of the regulatory changes have already been announced, they're unlikely to be changed, and the complexion of Congress is unlikely to impact some of the momentum we've seen from a regulatory backdrop in terms of Federal Reserve stress tests, bank balance sheets, and that could be a boon for financials as they have a greater flexibility of their balance sheets to open up greater investment for return on equity. I think another point around industrials and aerospace and defense, so largely you'll still see an increase in defense spending no matter where the congressional makeup is made up of Republicans or Democrats. I think they'll still be that impulse to spend on defense, and that could act as an impulse on aerospace and defense in terms of fundamentals and on the broader sector too from a price momentum perspective. So these midterms, there is some action points, but it's largely due to the status quo staying the status quo as many of the policy changes that are impacting the markets are less coming from the legislative branch and more from the executive branch. We're seeing more macro push and pull in terms of headlines and narratives and driven from that perspective.