Looming Interest Rate Hike a Boon for Bank Stocks

Fed Rate Hike Will Be Huge for American BanksThis Could Be a Big Catalyst for Bank Stocks

After almost a decade of artificially low interest rates and nonexistent fixed income, it might be time for American banks re-enter the spotlight. Thanks to ultra-low interest rates and tighter regulations, U.S. banks have been languishing in the shadows. With higher interest rates as close as one month away, America’s banking stocks are on the verge of finally making some serious money.

Bank Stocks to Benefit from Rising Interest Rates

With a rate hike on the horizon, the fuel that propelled the stock market considerably higher since 2009 may be starting to run dry. This will have profound implications on the current bull market and where investors park their money.

Stocks that performed well during the low-interest-rate environment may not perform as well in a rising-interest-rate environment. Of course, rising interest rates suggest the U.S. economy can withstand a rate hike.

On paper, the Fed has the data to back it up: unemployment is down, there is some evidence of wage growth, the European economy is on the mend, and even the Shanghai Composite Index is in bull territory. (It may not have fully recovered from Black Monday, but it is up 28% from its trough on August 26.)

While the new higher-interest-rate economy will favor some sectors more than others, 2016 could be the year that U.S. financial stocks get what they’re due. Even if a December rate hike is miniscule and turns out to be a one-off until the economy improves even further, the stage has been set and investors will be changing the way they invest.

Stocks that thrived in a low-interest-rate environment will fall out of favor. Those that have been hurt by artificially low interest rates will start to thrive, but none more so than banking stocks.

Suffering Ends for Financial Stocks

For obvious reasons, banking stocks have not performed all that well since the Fed introduced its first round of quantitative easing (QE). The $150-billion-plus in bank fines and penalties related to the financial crisis certainly didn’t help either.

You can add the bank stress tests to this list of failures, too, though admittedly, it’s probably good that the banking stress test is in place.

The Comprehensive Capital Analysis and Review (CCAR) and Dodd-Frank Act (DFA) stress tests are regulatory tools used by the Federal Reserve to measure a bank’s ability to withstand a crisis. Only banks with assets of more than $10.0 billion are subject to the test.

The stress tests are important because banks that pass can return money to shareholders in the form of dividends and share repurchase programs. This is an important motivator for banks that want to appease investors and look like a viable business.

Case in point: in 2007, before the financial meltdown, Bank of America Corporation (NYSE:BAC) paid out an annual dividend of $2.40 per share. In 2008, it tightened its belt to $2.24. Between 2009 and 2013, the company provided an annual dividend of $0.04—that’s just one cent per quarter. It wasn’t until the second half of 2014 that the bank raised its quarterly dividend from $0.01 to $0.05. (Source: “Bank of America Dividend History,” Bank of America Corporation, last accessed November 12, 2015.)

Underperforming Bank Stocks Set to Thrive

After years of underperforming and disappointing investors, America’s big banks are about to start making serious money off higher rates and your deposits. Who will be the biggest winners? Those with the most money.

Investors wanting to add the country’s largest banking stocks to their investing portfolio may consider doing so through a variety of financial sector exchange-traded funds (ETFs), including Financial Select Sector SPDR ETF (NYSEArca:XLF), SPDR S&P Bank ETF (NYSEArca:KBE), and iShares US Financials (NYSEArca:IYF).

You can also consider adding U.S. banking stocks to your portfolio individually. U.S. banking stocks with the largest deposits include JPMorgan Chase & Co. (NYSE:JPM) with total assets of $2.59 trillion, Wells Fargo & Company (NYSE:WFC) with total deposits of $1.2 trillion, and Bank of America Corporation with total deposits of $1.6 trillion.

While there is no guarantee the Feds will raise rates in December, we do know that they will in 2016. With that in mind, now might be a good time to start researching U.S. financial stocks.

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