Financial stocks are at their highest level in five years, but more upside could be in store if the Federal Reserve indeed tapers its quantitative easing policy in the next six to twelve months.
Financial stocks are uniquely positioned to benefit from a tapering scenario. A reduction in quantitative easing, in conjunction with a continuation of the near-zero fed funds rate through 2016, virtually guarantees a steeper yield curve (causing long rates to rise while short rates stay flat). A steeper yield curve is a major plus for banks because it boosts their net interest margins. It also provides a tailwind for certain insurance companies by allowing them to earn a higher rate on their investments.
This dynamic is reflected in financials’ strong performance during the two intervals in which Treasury yields have moved higher. In the first — April 30 through August 31 — the Financial SPDR (XLF) rose 3.96%, outpacing the 3.03% gain of the SPDR S&P 500 ETF (SPY). In the second — October 31 through Thursday, November 21 — XLF has tacked on 4.5% and strongly outpaced the 2.34% gain for SPY.
While this headline return is positive, a closer look at the financial sector shows that certain areas have performed much better than others. The table below shows that large-cap banks, as a group, delivered robust returns during the two periods of rising rates. Of the ten shown, four — Bank of America (BAC), US Bancorp (USB), Bank of New York Mellon (BK), and SunTrust Banks (STI) — outperformed the broader group in both intervals.
|Stock||Ticker||Return, 4/30-8/31||Return, 10/31-11/21|
|Bank of America||BAC||14.8%||11.6%|
|PNC Financial Services||PNC||7.1%||3.8%|
|Bank of New York Mellon||BK||5.9%||6.0%|
|S&P 500 ETF||SPY||3.0%||2.3%|
But banks aren’t the only ones who benefit from rising yields…