Financial Stocks Should Pay Off: An Overview of Promising Opportunities

Financial stocks are currently in a favorable position. As of late 2024, lower short-term interest rates, an expanding economy, and strong third-quarter results have boosted shares of businesses that offer financial products or services. The outcome of the U.S. presidential election further fueled this surge, as Wall Street anticipates a bank-friendly administration.

Over the past year, financial shares have surged 31%, surpassing the S&P 500's 25% return, as well as most other sectors, with the exception of communications services and information technology. Analysts predict a 15% increase in earnings for the financial sector in 2024 compared to a 10% increase for the S&P 500.

Outlook for 2025

Analysts expect financial companies to see earnings growth of 7% to 9% in 2025. This growth is considered supportive, especially considering that the sector trades at a discount to the broader market. The financial sector's price-to-book ratio is currently at a 52% discount to the S&P 500, compared to a typical discount of 44%.

Key Factors Driving the Financial Sector:

• The economy has likely avoided a recession, which is beneficial for banks.
• Short-term interest rates are decreasing, while longer-term rates are rising, resulting in a less inverted yield curve, which is good for the financial sector.

However, investors should be selective about where they invest within this sector.

 

Promising Areas within the Financial Sector:

• Asset Managers: Strong stock returns and new cash inflows have boosted assets under management. As more people approach retirement, the need for professional financial guidance is expected to increase and the industry expects growth of 34% a year until 2032. Companies with a strong grasp of technology and a solid position in alternative assets, private equity and debt markets will have an advantage.

  • BlackRock (BLK) is a major player in this area, with its popular exchange-traded funds and Aladdin technology platform driving growth. BlackRock has been acquiring other companies to expand in private markets and alternative assets. The stock is considered affordable with a P/E of 21, which is just above that of the average asset management firm.

• Investment Banks: Lower interest rates will encourage initial public offerings and mergers and acquisitions.

  • Goldman Sachs (GS) has been recommended as a stock to buy as its business is doing well. The firm had strong third-quarter results in 2024, with double-digit revenue growth in nearly all of its business segments. Analysts expect 18% annualized earnings growth over the next three years.

• Property and Casualty Insurers: The property and casualty insurance sector is experiencing an upturn.

  • Willis Towers Watson (WTW) is an insurance brokerage firm showing signs of improvement due to cost-cutting and restructuring efforts. Its cost cutting and restructuring efforts may lead to a 5% jump in earnings. The interest in cybersecurity could also boost its results.

• Regional Banks: Regional bank stocks have begun to recover after the failures in 2023, which included Silicon Valley Bank. Lower interest rates have helped, as these banks depend on the difference between the interest they earn on loans and pay on deposits.

  • Bank OZK (OZK) is considered a good option because it's currently trading at a discount. Although there are some concerns about commercial real estate exposure, they tend to be conservative and partner with strong developers.
  • PNC Financial Services (PNC) is the largest regional bank, serving fast-growing states and is considered well-managed.
   
  

Ways to Invest:

• Diversified Financial ETFs: Consider iShares U.S. Financials ETF (IYF) or Financial Select Sector SPDR ETF (XLF) for broad exposure to the financial sector.
• Actively Managed Mutual Funds: Fidelity Select Financials Portfolio (FIDSX) or T. Rowe Price Financial Services (PRISX) are actively managed mutual fund options.
• Industry Specific ETFs: For more focused investment, look at Invesco KBW Property & Casualty Insurance ETF (KBWP) which focuses on the insurance sector, or iShares U.S. Regional Banks (IAT) which focuses on the regional banks.

The financial sector presents several promising investment opportunities as it continues to grow. It is important for investors to be selective within the sector and to consider both broad and targeted investment options.