The Federal Reserve threw a bit of a curveball last week when Janet Yellen dropped the word “patient” from the Fed’s statement, but made it clear that the FOMC was still going to be prudent in waiting for clear signs of an improving jobs market and economy before making their first hike to interest rates.
Click to Enlarge Don’t get confused, though — rates are going to go higher this year.
But contrary to popular belief, rising rates aren’t blindly bad for stocks. Our research has found that there are some sectors benefit from higher rates.
One sector that experiences expanding margins thanks to higher rates is banking. Conveniently, bank stocks are among the most hated sectors out there according to current analyst rankings. This is valuable to know, as history and research suggest that under-loved sectors tend to outperform the market — especially when they have a positive catalyst like bank stocks have now with the imminent rate hikes.
Using our behavioral valuation models, we’ve nailed three bank stocks that should thrive and leave the market behind as the FOMC initiates its rate increase.
Bank Stocks to Buy: SPDR KBW Bank (ETF) (KBE)
First up, rather than target a single stock, we’ll look at a whole basket of them.
Investors usually flock to the financial-based ETFs like the Financial SPDR (NYSEARCA:XLF) when they think about investing in banks, but for this purpose, we would rather focus on actual bank stocks, not companies that are tied-up with investment banking, currency trading or other tangential businesses.
The SPDR KBW Bank (ETF) (NYSEARCA:KBE) replicates the performance of the S&P Banks Select Industry Index, which includes 63 banks — both money center and regional — across the U.S.
After trading in a range for more than a year, KBE appears ready to make a move through the top of the range just as higher interest rates will likely spark an expansion in margins. Wall Street is on the wrong side of this trade with only 40% of the recommendations within the ETF falling in the “buy” category. We expect to see that number begin to rise as analysts realize the potential of the banking stocks to outperform the market as rates move higher.
You can afford to be patient here as the KBE will probably test support at $33 before moving higher. Don’t wait too long, though, as shares will start to move faster than the market after breaking above the $34 level, with a target of $40 before year’s end.
Bank Stocks to Buy: First Horizon National Corp (FHN)
A relative strength leader among bank stocks, First Horizon National Corp (NYSE:FHN) is set to break higher as short sellers get squeezed and as analysts should be forced to upgrade shares to avoid looking too far behind.
FHN shares saw an increase in short interest through February as short sellers raised their bets that First Horizon would falter back into its trading range. With shares now settling into an intermediate-term bullish trend, the shorts are sure to get squeezed out soon, propelling shares even higher.
First Horizon has posted positive earnings surprises in seven of the last eight quarters — a trend that should remain strong as margins begin to expand with higher rates. The combination of strong technical performance along with fundamental improvements should make it only a matter of time before we see the analyst community step up to upgrade shares from its current 20% “buy” consensus.
A break above the $15 level should target a year-end price of $20, or a 40%-plus gain.
Bank Stocks to Buy: PNC Financial Services Group Inc (PNC)
PNC Financial Services Group Inc (NYSE:PNC) is a Pittsburgh-based financial services company that operate six different divisions including banking, mortgage services and asset management — all of which should benefit from higher rates.
The fundamental performance of PNC has been impressive, outpacing earnings expectations in all eight of the last eight quarters. But despite the fundamentals, only 29% of the analysts covering PNC have it ranked a “buy.” The low analyst view on the stock makes no sense when looking at the fundamentals and the stock’s chart … so it looks like the analysts will just have to play catch-up at some point.
Technically, PNC shares have been one of the stronger among the banking companies as the post a 12-month gain of 11.5% and are trading in an strong positive trend.
Currently, our technical models score PNC as a “strong buy” with a target of $110 within the next four to six months.
As of this writing, Johnson Research Group did not hold a position in any of the aforementioned securities.