Financial Sector Showing Strength for 2014

We are more than two weeks into 2014 and the S&P 500 is essentially flat with mixed economic data being reported over this time period. The sector that had a great year in 2013 and is starting the new year off with positive news on the earnings front is the financial sector and more specifically the banking industry. The KBW bank index is up 1.5% this year even with two down days to finish this week. The top six banks in the U.S. had profits in 2013 that were just shy of their peak in 2006 and similar expectations are in place for smaller, regional banks who will be reporting earnings soon.

The are a number of factors that are driving this strength including the fact that banks have been reducing costs over the past 5 years, rising long-term rates have increased profits margins and a strengthening economy allows them to lower their bank reserves.

The strength in this industry bodes well for the general economy and market since a healthy banking industry will lead to increased business, consumer and real estate lending. The lending ratios for banks have been well below historical averages over the past 5 years. The one area that could benefit most by increased lending are small businesses who don’t have access to the same financial markets as corporations. This will in turn flow through to the labor markets since small businesses are the biggest force in determining the health of the labor markets.

From an investment perspective, there are certainly challenges for the financial industry with increased regulation, profit margins at all-time highs and above average valuations in their stocks but there are more positive factors then negatives ones as we forecast for 2014.  We may not see the same level of return in the financial sector that we did in 2013 but it is in a good position to be one of the strongest sectors for the year.