This Market Rally Still Has Legs – and the Financials Should Lead It

Good news. Bad news. It seems like the market has been ignoring both, and steadily grinding higher regardless. Given how complacent and how high the markets are, it’s only natural to wonder when and how the rally will end. The good news, though, is that I don’t think it will soon.

Over the course of time, central banks have been the biggest, indirect creators and destroyers of economic expansions. And it’s hard to argue that our Fed and its counterparts overseas could have done more to spur growth than they have in the past several years. Negative interest rates, troubled asset purchases, bond purchases, bankruptcy bailouts – we’ve seen it all.

The Fed is beginning to backtrack on some of those policies, and that’s likely to cause more volatility. But central banks the world over are still very accommodative and loose with their wallets. That should ultimately fuel this rally further, with financials likely to lead.

One key reason is that they benefit from rising rates, and that’s exactly what we’re getting. Fed funds futures traders are pricing in a 90% chance that we’ll see another 25 basis point increase in the funds rate at the Fed’s December meeting. But that would leave rates in a range of just 1.25-1.5% — still very low, and still accommodative. For comparison’s sake, that rate was as high as 5.25% in May 2007 before the Great Recession.

Banks had been showing relative underperformance for most of 2016 and 2017 thanks to regulatory hurdles, increased costs, and the low interest rate environment. But further rate hikes will increase the spread between the rates they earn from loaning money out versus the rates of interest they have to pay on deposits. That wide spread, or margin, will drive bank profitability higher.

In fact, one hedge analytics tool recently calculated that the average return for financials was 10.7% if you bought them 44 days prior to a rate increase, and sold on the day of the hike. The strategy paid off in all four out of four occurrences since October 2004.

With that in mind, take a closer look at this list of top-rated banks (filtered for market cap and trading liquidity):

You’ll see there are a lot of A-rated names on this list. So if you think our stock rally is still on, and are looking for a way to put money to work into year-end, take a closer look at these financials.

Best,

Mandeep

Small Cap Edition, By Mandeep Rai, Senior Analyst Mandeep Rai has more than 15 years of investing experience, working as both a stock and credit analyst. At Weiss Ratings, he researches and evaluates financial and economic themes, and makes decisions on when to buy or sell specific shares for the Top Stocks Under $10 portfolio.