The friendly folks at Goldman recently ran a regression of which sectors do well with rising rates.

If you can’t read the chart below, rising rates are bad for stocks in the consumer, utilities, and software sectors, while they tend to support energy and financial services.

To answer why, rising rates often coincide with stronger economies, which support credit and energy consumption. Another factor is that when rates rise, quality banks earn more profit against their checking accounts. A bank like Silicon Valley Bank can see its margin vary from 2.5% all the way up to 6% off this basis.

Financials have already been outperforming materially the last 6 months. The sector outperformed the tech-heavy Nasdaq 100 despite relentless inflows into popular technology funds like ARKK. Part of this was from vaccine promise, but a rising 10 year treasury bond yield was a constant friend to banks in the process.

Last 6 months – KBE – Banks (black line); QQQ – FANG etc., yellow line

To be sure, we are not interest rate strategists, but it’s clear a trend in goverment bond markets has established itself. Below is the 10yr bond yield, which after making a series of highs is above the level of Feb 28, 2020. Recent progress with vaccine rollout and a supply of ~$12 trillion of bonds for sale this year has helped the rising yield story.

So why financials over tech when tech is where the innovation is?

First, off the top of your head can you name a recent innovation from Facebook, Apple, Netflix or Google other than buying competitors or increasing prices? In contrast the market may be underestimating the innovation taking place at Live Oak Bank, currently 21x forward earnings and re-configuring how banks interact with technology.

Second, most of FANG plus Tesla, while enjoying solid returns on capital, are at triple the valuation on earnings vs banks, or more. When looking at a combination growth rates, margins and valuations, many smaller emerging banks look attractive in comparison.

One final note – those that read this blog know that Colarion carries a strong preference for differentiated financial companies – banks / banks involved in fintech or fee businesses with a localized monopoly or new angle that competitors can’t easily replicate. We would not be surprised to see that subset “outperform the outperformance” in 2021.