3 Reasons You Should Buy Financials In The Second Half Of 2015

In a year where a great amount of value has been lost in investments such as Energy, Basic Materials, and Utilities; value can be found in those that benefit from the inevitable Fed actions taking place later this year. The Financials sector has grown a mere 1.6% despite a rather bullish outlook for the group. Here are 3 reasons why you should allocate a significant amount of invest-able funds into the Financials sector, banks specifically:

1) Raising rates will cause Net Interest Margin to increase, growing revenues – the popular measure tracks how much banks earn when they borrow from depositors and then lend or invest the same funds. Net Interest Margin is the difference between the interest income generated and the amount of interest paid out to their lenders, relative to the amount of interest-earning assets. When rates are raised later this year, be it September or December, the net interest spread will become wider and thus produce larger interest-related revenues for banks especially.

2) Decreasing regulation enables a higher degree of freedom – With the Republican party having a majority in both the house and senate, many see restrictions on financial institutions beginning to loosen and allow banks to pick up activity in areas such as trading. This was somewhat evident already as BB banks such as Goldman Sachs and Morgan Stanley beat quarterly estimates due to a surge in trading revenue.

3) Losers can be winners also – As of late, the financial sector has been a prime example of the concept contagion. News of one bank’s actions have impacted the day-to-day stock performance of other banks. Since I expect many banks to beat estimates in the coming quarterly reports, financial stocks that stay in-line with or slightly disappoint estimates are still worthy of a buy because of the greater outlook for the sector.

Here’s what to buy

As many of you have probably realized over the course of this year, the process of raising rates is a waiting game to say the least. Not just for consumers but for the banks as well. However, the market is smart and will pick up on the effects of the rate change before it actually happens, meaning the sooner you claim a stake in these banks and financial stocks, the better. The stocks that will produce the highest returns, even before the rate increases, are the ones that can rely on growth in other divisions during the short-term. That being said, growth is more likely in smaller, regional-sized banks. Finding this type of bank stock, at a cheap price relative to industry and sub-sector, is the key to taking advantage of this inevitable Fed action. Here are two that I have put some clients in over the past couple of months:

• PNC Financial Services (PNC) is a US-only regional bank based out of Pittsburgh. With the majority of their business coming from Retail and Corporate Banking, they stand to heavily grow revenues from the rising rates. At the same time, their Asset Management business is still in its early stages, growing 8% in Q2 from the same period a year ago, which contributed a significant amount to its bottom-line surprise. PNC also has a 25% stake in BlackRock, providing it with another source of income as well as diversification. PNC is rather cheaply priced right now with a PE of only 13.7.

• SunTrust Banks (STI) is a direct competitor with PNC, deriving even more of its business from consumer banking. However, STI grew its Investment Banking business by 22% in Q2 from a year ago, mainly derived from targeting Silicon Valley companies and startups. SunTrust has been able to get into large deals such as the Fitbit IPO by initially supplying the company with a line of credit, a less profitable business, and then using that to gain a seat at the table when it decides to publicly file. This aggressive move has landed the bank at a much higher ranking this year in league tables for technology IPOs. SunTrust is currently priced at 12.9 times earnings.

I hope this helps you shape an investment thesis of your own for 2015 and 2016 moving forward. It is not very often in the market when you are as sure of a macroeconomic event as we are right now on the Fed moving rates. I would highly suggest taking advantage of it by buying cheap shares in the Financials sector.