The media have made much ballyhoo in recent days out of the Volcker Rule, which bars Wall Street banks and other financial institutions from using their own money to make speculative investments.
But I think this headline noise has been priced into financial stocks for some time. And it gives us an opportunity to get more exposed to the sector without taking on excessive short-term risk.
The main force facing all financials, regardless of the particular industry they operate in, is the outlook for interest rates and the shape of the yield curve. My bet is that the long end of the curve (longer-term bond yields) will rise and fall violently as the Federal Reserve transitions to new leadership over the next six months. Ultimately, rates will move higher with or without Fed guidance, based on renewed economic growth, which I expect to be evident before the end of 2014.
|The financial services sector is poised for a rebound in 2014|
But I also think the new Fed leadership is likely to act more dovish for longer than expected. In other words, expect a lot of lip service before any action is taken — be it tapering or actual tightening. As a result, we’re entering a sweet spot in the lending community, where the economy picks up and firms rush to borrow to fund put-off expansion projects from the past five years. The market, not central banks, will determine the appropriate rates, and the firms will adapt to their new environment. Therefore, banks will rely more on commercial lending rather than consumer loans to fuel near-term profits.
Insurers will eventually have more profitable investment alternatives for their premiums. But, for now, the rate environment alone looks favorable for the property-casualty insurance industry. I expect the same lag that helps banks (long rates remaining more favorable for longer) to help other long-term investors, like insurers.
Of course, not all financial-sector stocks are built the same. And I favor those that sport a strong rating. For example, here are a few ideas to consider:
In banks, I like PNC Financial (PNC) and Wells Fargo (WFC), both rated A by the Weiss Ratings model. If you are a more aggressive investor, you might consider Huntington Bancshares (HBAN), a smaller bank that has an even higher A+ rating.
As for insurers, I like property-casualty plays. And two A+ stocks in the ratings model’s assessment that can be short-term winners are Chubb (CB) and ACE Limited (ACE), both having managed through tougher patches than the current one. I also like insurance broker Aon PLC (AON) in this area for longer-term horizons.
I have not yet seen a compelling reason to jump aboard investment managers. But as the economic rebound progresses, I’d steer toward high-rated stocks like T. Rowe Price (TROW).
Higher interest rates will ultimately benefit financials. So any of the above are strong long-term picks.
However, I expect interest rates to rise slowly over the next year, so I am willing to put my 2014 money in play with a couple of lower-rated names in banking and insurance that I think will make a fundamental (and subsequent ratings) rebound during the next 12 months, based on this conservative outlook.
These “fallen angels” have improving fundamentals and rising sentiment going for them. Yet Wall Street isn’t giving them much attention. Visit our Facebook page to see them.