Financial sector-related stocks are set to potentially outperform this year as the Federal Reserve is expected to issue multiple interest rate hikes, something the central bank hasn't done in three years. The Fed has signaled that it will likely start raising rates in mid-March.
The Fed has kept interest rates low for most of the past decade, and near-zero throughout the coronavirus pandemic. The financial sector is one of the most sensitive sectors to chains interest rates, as their profit margins typically expand with rates climb and contract with rates fall. Financial entities like banks, insurance companies and brokerage firms usually benefit from rate hikes.
As the Fed moves to raise rates, banks could benefit from gains in their net interest income--the difference between what banks earn from lending and pay out on deposits--especially as a healthy economy usually leads to more loans.
JPMorgan & Chase (NYSE: JPM) has already told analysts earlier this month that it projects net interest income from its businesses beyond securities to increase to $50 billion in 2022, according to Reuters, up 12% from last year's $44.5 billion. The bank said that the changes in rates will only account for one-third of its expected increase, with the majority gains coming from loan growth.
JPM and Citigroup (NYSE: C) also said they expect more interest income to come from credit cars as consumers resume incurring interest charges instead of quickly paying down balances as they have throughout the pandemic, Reuters reports.
As for other financial entities, higher interest rates generally leads to growth for insurance companies as improving consumer sentiment towards economic conditions leads to more car purchasing and home sales, resulting in more issued policies. Brokerages also benefit from more investment activity and increased interest income from rising rates.
Bank of America (NYSE: BAC) economists said in a report on Friday that they expect the Fed to raise rates by 25 basis posts seven times this year, starting in March. "The Fed has all but admitted that it is seriously behind the curve," BAC economists wrote. However, BAC has one of the more aggressive views on rate hikes, as other banks like Deutsche Bank (NYSE: DB) expecting five hikes, while TD Securities (NYSE: TD) only expects four.
There are several board financial-sector exchange-traded funds that could benefit in a higher rate environment this year. These include the Financial Select Sector SPDR Fund (NYSE: XLF), iShares U.S. Financials ETF (NYSE: IYF) and Vanguard Financials ETF (NYSE: VFH). For the investor that it looking for pure-play bank ETFs, options include the iShares U.S. Regional Banks ETF (NYSE: IAT), SPDR S&P Regional Banking ETF (NYSE: KRE), and SPDR S&P Bank ETF (NYSE: KBE).