It’s been a good year for banking and financials investors, and it could even get better in 2018.
The big banking exchange-traded funds — Fidelity MSCI Financials (ticker: FNCL, up 34.5 percent over the past year), iShares U.S. Financials ( IYF, 6.55 percent), and Vanguard Financials ( VFH, up 34.5 percent) are going great guns, bolstered by substantial shareholder dividends and generous stock buyback programs on the part of financial firms.
Also helping financial stocks and funds is stronger U.S. gross domestic product growth (up 3.1 percent in the second quarter) and the prospect of lower corporate tax rates, which would benefit big financial institutions.
That growth accelerated in September, with the benchmark KBW Bank index up 6 percent for the month, substantially higher than the Standard & Poor’s 500 index rate of growth over the same period.
[See: 11 Ways to Buy Bank Stocks.]
Individually, bank stocks have been hot, as well. Citigroup (NYSE: C), was up 6.7 in September, while Bank of America Corp. ( BAC) rose by 6.6 percent. Wells Fargo & Co. ( WFC) grew 6.2 percent and JPMorgan Chase & Co. ( JPM), saw its shares jump 4.9 percent.
What could really propel bank stocks is the Federal Reserve’s expected interest rate hike, most likely coming by the end of the year.
“Big banks will benefit from rising rates due to the healthy percentages of floating rate loans and securities on their balance sheets, but how much they benefit relative to regional bank peers may be impacted by a few factors,” says Mike Cronin, U.S. equities analyst at Aberdeen Standard Investments in Boston.
For example, a portion of the net interest income (the spread between what they charge their customers and what they need to pay their depositors) for the big banks comes from outside the U.S., Cronin says.
“To the extent that rates rise in the U.S., and stay flat elsewhere around the world, some big banks may not benefit as much,” he says. “In addition, higher levels of commercial deposits, which will have higher deposit betas as rates rise, may also impact asset sensitivity benefits.”
Cronin says Bank of America seems best positioned for rising U.S. interest rates as a higher percentage of its revenues come from the U.S., and it has more retail deposits relative to peers.
The other main factors impacting bank stocks are regulatory reform and tax reform.
“Regulatory reform has the potential to lower capital requirements modestly for the banks and drive returns higher,” Cronin says. “Tax reform would also be meaningful as banks have higher tax rates relative to other sectors, and could see meaningful benefits to earnings per share and returns from lower tax rates. Bank stocks seem to be mostly incorporating the benefits of regulatory reform now, but if meaningful corporate tax reform is passed, there could be upside to the group.”
[See: These Are the Best Major Bank Stocks.]
Some banks may offer more profit potential than others, investing experts say.
“Banks earn much of their revenue from net interest income,” says Deanne Butchey, senior lecturer at Florida International University. “As a result, different banks, depending on their clientele and the way they finance their loans, will benefit differently in this environment.”
Retail banks (those that get most of their deposits and loans from the smaller players) can be more profitable than banks that are more focused on institutional clients. “The big banks, like JP Morgan, Citi, Bank of America and Wells Fargo are extremely diversified in terms of location within the United States, and are thus sheltered from wild swings caused by disasters,” Butchey says.
Big banks are also in a better position to invest in innovative banking features, and can earn additional fees from these offerings. “Additionally, they have deep enough pockets to mitigate against hacking and other technology-related vulnerabilities,” she says. “Big banks can also offer wide-ranging financial services which usually benefit during periods of strong stock markets, as we are witnessing today.”
There is some diversity in terms of investment potential among big banks, too.
“Now that Wells Fargo is under intense scrutiny, more negative press may hamper further short-term stock gains,” Butchey says. Also, JP Morgan Chase is currently at an all-time high, so the stock is priced for perfection, like the stock markets. Citigroup and Bank of America have recovered from their depths 10 years ago but are still far from their all-time highs.”
Given that these banks are more focused on retail banking, there may still be some room for stock price increases, though. “Bank stocks will have large fluctuations only if the Fed moves interest rates quickly since their managers will not have a chance to adjust their portfolios mitigating their risks,” Butchey says. “However as we have seen, it is hardly likely that the Fed will move too quickly to cause this to happen.”
When push comes to shove, it may be that imminent Federal Reserve rate hike that really pushes bank stocks forward.
“It’s expected that a rise in interest rates would positively affect bank profits by enabling banks to increase the interest margin between loan and deposit rates,” says Evgenia Konovalova, a stock market analyst at FxPro, a foreign exchange broker based in London.
“Often, the Fed proceeds to a rate hike in response to strong economic performance and a rise in consumer spending. September saw record car purchases in the U.S., in part purchased on credit, which generally has a favorable effect on bank indicators,” Konovalova says. “Banking finances also look stronger as a result of falling unemployment and, consequently, of the decrease in non-performing loans.”
[See: These Are the Best Regional Bank Stocks.]
Right now, bank stocks and funds are percolating nicely, especially the big financial institutions. If the Fed boosts interest rates, expect a flood of money into financials — and sooner rather than later.
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There’s Bullish Sentiment for Bank Stocks Through 2018 originally appeared on usnews.com
