At the immediate onset of the novel coronavirus pandemic, I’m sure almost everyone had the same initial gut reaction: the economy was about to enter a recession. Generally speaking, it’s difficult for a nation to avoid significant fiscal damage when commercial activity slows to a crawl. However, the U.S. has been blessed, thanks in large part to unprecedented fiscal support. But that can’t last forever, which is why investors should consider financial stocks.
In early August of this year, Wall Street Journal writer Nick Timiraos wrote that the Federal Reserve now has the option to consider “lifting interest rates from near zero by early 2023,”citing Fed Vice Chair Richard Clarida’s opinion on the matter. The way the central banker sees it, “commencing policy normalization in 2023 would … be entirely consistent with our new flexible average inflation targeting framework.” If so, the backdrop would be favorable to financial stocks.
As an Investopedia article pointed out, the “financial sector has historically been among the most sensitive to changes in interest rates.” Basically, institutions in this segment see their profit margins rise as rates swing higher. Therefore, investors should consider looking at financial stocks levered to businesses such as banks, insurance firms and brokerages as a hedge against the coming impact of Fed policy.
Indeed, the time to start preparing may be now. Just recently, the BBC reported that the Federal Reserve “could begin withdrawing stimulus this year as the economy rebounds,” per Fed chair Jerome Powell. To be fair, the world’s most powerful central bank is “in no rush to raise interest rates despite a recent spike in inflation.” Still, investors should plan for the very real possibility that financial stocks could have a long upside pathway ahead.
With aggressive monetary and fiscal policies combining to create unusual circumstances in the economy and the market — just take a look at the wild speculation in the equities sector — those who control the shots will certainly want to scale back the fever. Should that turn out to be the case, these financial stocks may benefit handsomely.
- JPMorgan Chase (NYSE:JPM)
- Morgan Stanley (NYSE:MS)
- Charles Schwab (NYSE:SCHW)
- Prudential Financial (NYSE:PRU)
- Travelers Companies (NYSE:TRV)
- Royal Bank of Canada (NYSE:RY)
- HDFC Bank (NYSE:HDB)
While the above talking points make sense, there’s also a point to be made that the economy could still require robust support. With the employment level only rising 2% between October 2020 and July 2021, there’s much work to be done. Therefore, treat these financial stocks as you would any other sector at this time — with caution.
Financial Stocks to Buy: JPMorgan Chase (JPM)
When wagering on shifting economic tides — such as the prospect of higher interest rates when the country has been lavishly consuming the abundance of cheap money — it pays to spread your risk. That applies to the financial sector as well. Under this strategy, it makes sense to go with the alpha dog and among financial stocks, that’s JPMorgan Chase.
According to ADV Ratings, JPMorgan is the world’s biggest bank according to market capitalization. At time of writing, this metric was over $487 billion. For context, the second-biggest bank in the world is Bank of America (NYSE:BAC), which presently features a market cap of just under $354 billion.
Buying into JPM stock, you get the confidence of a company that generated revenue of $119.5 billion in 2020, up 3.6% from the $115.4 billion posted in the prior year. On a trailing-12-month basis, JPM is looking at top-line sales of $121 billion.
If or when monetary policy normalizes, look for JPM to shore up its interest income. Last year, it was $64.5 billion, down a shocking 23% from 2019’s tally.
Morgan Stanley (MS)
Ranked as No. 8 on the list of the biggest banks in the world by market cap, Morgan Stanley is particularly notable for its role in investment banking or the underwriting of financial products. Spearheading Benzinga’s coverage of initial public offerings, I’ve noticed that Morgan Stanley comes up quite often as a lead or joint bookrunner for enterprises undergoing an IPO.
I’m biased of course so take this opinion with a grain of salt. But I don’t think that the wave of companies going public is going to abate anytime soon. With a new generation of people gaining knowledge of the market — in part due to the meme stock phenomenon — those companies seeking to raise funds from retail investors know that this is as good a time as any to launch an IPO.
Also, you have the other phenomenon known as special purpose acquisition companies or SPACs. With so many options on the table, Morgan Stanley is going to be very busy. Therefore, you might want to add it to your list of financial stocks to buy.
Financial Stocks to Buy: Charles Schwab (SCHW)
Falling a bit outside the top 10 list of the world’s biggest banks, Charles Schwab is no slouch, coming in at No. 12. While the company has performed well during the pandemic, with revenue of $11.7 billion in 2020 representing a year-over-year increase of 9%, it will almost surely benefit from a bump up in benchmark rates.
In 2020, Charles Schwab’s interest income tallied $6.53 billion, a loss of 14% from the $7.58 billion posted in 2019. Given how eager the Federal Reserve is to manage the economy away from the free-flowing monetary spigot, the bank will probably get what it wants.
But another factor to consider is its second quarter of 2021 earnings report, which saw revenue of $4.53 billion representing a YOY lift of nearly 85%. That’s just bonkers, driven by retail investor sentiment.
In October 2020, Charles Schwab acquired TD Ameritrade, which has been nothing but a benefit to the former organization. With so much interest in equities-based opportunities, SCHW is one of the financial stocks to keep a close eye on.
Prudential Financial (PRU)
As I wrote for Benzinga, “Because of the uncertainties of the coronavirus, many people asked themselves about the financial security of their families in case the worst happened. Therefore, it’s likely that demand for life insurance coverage will increase following this once-in-a-century pandemic.” As one of the top providers of such protection along with several other pivotal financial products, Prudential Financial certainly belongs on your radar.
One of the factors that support the case for insurance-based financial stocks is that they’re boring. True, if you’ve got time on your hands — meaning that retirement is decades away — you typically want to have a growth-oriented portfolio. But these aren’t typical circumstances, and no one really knows how the economy will pan out over the next few years.
To be fair, Prudential did take a hit when the pandemic struck. In 2020, the company generated revenue of $57 billion, which was down 12% from 2019’s result. However, on a trailing-12-month basis, Prudential has rung up sales of $63.7 billion, which is in line with sales trends posted just before the pandemic. Should society normalize and rates rise from their extreme lows, this should be a positive for PRU stock.
Financial Stocks to Buy: Travelers Companies (TRV)
One of the most well-known insurance firms, Travelers Companies offers an extensive range of protective products, from your typical home and auto insurance to wedding and events insurance. As well, Travelers fills demand for burgeoning segments, such as pet health insurance programs for dogs and cats. And true to its brand, the organization also offers travel insurance.
As we navigate this new normal, one segment that should perform well for Travelers Companies is naturally home protection programs. Over the course of this global health crisis, the S&P/Case-Shiller U.S. National Home Price Index has been soaring to record levels. Obviously, it’s not going to reach such plateaus if it weren’t for unadulterated buying pressure.
For those that are taking the plunge with home ownership post-Covid, they’re likely extra incentivized to protect their biggest investment. Not surprisingly, while Travelers’ revenue for 2020 was a hair above parity with 2019, over the trailing-12-month period, the company is on pace for sales of $33.7 billion, up over 5% from 2020’s result.
Further, additional relevant programs like landlord insurance — the other component of the eviction crisis that doesn’t get as much coverage — should keep Travelers busy, making it one of the more dependable financial stocks to buy.
Royal Bank of Canada (RY)
While the Federal Reserve looks out for “No. 1” first and foremost — the U.S. — what usually happens in this country filters on up to Canada. A few months back, the Bank of Canada dropped hints that it would hike interest rates before the Fed did, which boosted the Canadian dollar on the news. Realistically, though, Reuters reported that our northern neighbors aren’t likely to stray too far from Fed policy.
But now that the Fed is also seemingly eager to at least stop the cheap money flow, this circumstance could have significant implications for Canadian monetary policy, and therefore, the Royal Bank of Canada. Recall that in the months leading up to the coronavirus pandemic, the Trump administration practically demanded heavy rate cuts to boost economic productivity.
At the time, the Bank of Canada considered a more dovish policy to offset the relative rise of the Canadian dollar, which would hurt our northern neighbor’s exports. With the U.S. presumably set to adopt a hawkish policy, the opposite dynamic will occur. To diversify your holdings of financial stocks, you may want to consider RY shares, which may benefit from the aforementioned monetary catalysts.
Financial Stocks to Buy: HDFC Bank (HDB)
Usually, financial stocks are boring, with investors often parking their money in this sector to protect their funds from severe volatility. However, such a move comes at a cost — you’re just not going to get much growth, especially if you’re banking on a prominent North American company. But if you want to stay in this segment but add some upside catalysts to the table, you may want to consider HDFC Bank.
As India’s largest private sector bank by assets and by market cap, HDFC Bank in a way offers the best of both worlds. For those who want to protect themselves with financial stocks ahead of rising rates, HDFC provides serious clout. At the same time, the institution also offers exposure to one of the most exciting emerging markets.
A few months back, The Week reported that “India will be the world’s fastest growing major economy in 2022,” citing data from the United Nations. To be fair to the UN, it did warn about the “highly fragile” circumstances surrounding the Covid-19 pandemic. Still, this is high praise, suggesting investors should direct some of their international exposure to India and specifically HDB stock.
On the date of publication, Josh Enomoto did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
A former senior business analyst for Sony Electronics, Josh Enomoto has helped broker major contracts with Fortune Global 500 companies. Over the past several years, he has delivered unique, critical insights for the investment markets, as well as various other industries including legal, construction management, and healthcare.