The widely expected interest rate hike was announced at the end of the two-day Federal Reserve Open Market Committee (FOMC) meeting yesterday. The federal funds rate, increased for the third time this year, now stands at 2-2.25%. At present, the rate is at the highest level in a decade.
Despite this, majority of the finance sector stocks ended the day in red, dragging down the S&P 500. Notably, the S&P 500 Financial (sector) and the S&P 500 Bank (Industry Group) indexes were down 1.3% and 1.5%, respectively. Further, SPDR S&P Bank ETF KBE declined 1.8%, while Financial Select Sector SPDR ETF XLF fell 1.2%.
Why Finance Stocks Ended in Red
Though rising interest rates are beneficial for the finance sector, the stocks witnessed a decline.
Well, market had been expecting a bit more hawkish stance with regard to the pace of rate hike next year and beyond. But the Fed stuck to the prior estimation of one more hike later this year, three increases next year and one in 2020.
While the minor changes in the statement including the removal of the word "accommodative" reflected the more aggressive stance, it didn't seem so from the projections released at the end of the meeting (remained unchanged from June 2018 forecast) and also at subsequent press conference.
The Fed Chairman Jerome Powell said, "The change does not signal any change in the likely path of policy. Instead it is a sign that policy is proceeding in line with our expectations." This led the stocks to fall as investors perceived it as unexpected.
Powell further added, "This action reflects the strength we see in the economy and is one more step in the process that we began almost three years ago of gradually returning interest rates to more normal levels."
It seems that change in language will likely provide the Fed additional flexibility as to how quickly it increases the rates. If the U.S. economic growth weakens or other problems materialize, the central bank can move less aggressively.
U.S. Economy to Grow at a Faster Pace
The Fed now projects economic growth at the rate of 3.1% for 2018, up from the previous expectation of 2.8%. Notably, this will be the first time since 2005 that annual growth will cross 3% mark. Further, the growth rate is anticipated to be 2.5% in 2019 (up from 2.4% projected earlier) and 2.0% in 2020 (unchanged from the prior guidance).
Based on the updated economic projections, the Fed still expects inflation to be 2.1% this year, above its target of 2%. The unemployment rate in 2018 is predicted to be 3.7%.
The upbeat outlook indicatesthat the domestic economy doesn't show any sign ofderailment owing to trade war, increase in oil prices and geopolitical tension.
Rising Rate Environment and Banks
The banking industry benefits the most from the rising rates. Banks derive benefits from a steep yield curve (widespread between short and long-terms rates). A rise in short-term rates (to which deposits are tied) helps banks charge more on loans (to which long-term rates are tied), if the long-term rates are higher than the short-term ones. So, banks gain from rising interest rates only if the increase in long-term rates is higher than the short-term ones.
Also, rising rates reflect an improving domestic economy. This implies that the credit quality is improving, which is great for banks' profitability as well. In addition, banks are expected to gain from easing of stringent regulatory restrictions and lower tax rates.
While the Fed's lesser-than-expected hawkish stance may dent near-term investor sentiments, over the longer run, steady rise in interest rates and improving economy will be beneficial for banks.
Choosing the Winning Bank Stocks
While all banks will benefit from rising rates, to pick a handful of these for your investment portfolio is not an easy task. To make this daunting work somewhat easy, we have taken the help of the Zacks Stock Screener .
Through it, we have shortlisted bank stocks with expected long-term earnings growth rate of 10% or more and market capitalization greater than $2 billion. Also, these stocks carry a Zacks Rank #1 (Strong Buy) or 2 (Buy). You can see the complete list of today's Zacks #1 Rank stocks here .
Further, these stocks have a Value Score of B. Our research shows that stocks with a Value Score of A or B when combined with a Zacks Rank #1 or 2 offer the best upside potential.
Here are the four bank stocks that met all the criteria set:
Headquartered in Weston, FL, FCB Financial Holdings, Inc.FCB has a Zacks Rank #2 and market cap of $2.3 billion. The company's earnings are expected to grow at the rate of 17.5% over the long term.
Huntington Bancshares IncorporatedHBAN , based in Columbus, OH, carries a Zacks Rank #2 and has market cap of $17.3 billion. Over the long term, the company's earnings are projected to increase at the rate of 14.6%.
With market cap of $4 billion, MB Financial, Inc.MBFI has a Zacks Rank #2. This Chicago, IL-based company's earnings are expected to grow at the rate of 10.5% over the long term.
Wintrust Financial CorporationWTFC , based in Seattle, WA, carries a Zacks Rank #2 and has market cap of $5 billion. The company's long-term earnings are expected to grow at the rate of 13.5%.
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Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free reportWintrust Financial Corporation (WTFC): Free Stock Analysis ReportHuntington Bancshares Incorporated (HBAN): Free Stock Analysis ReportMB Financial Inc. (MBFI): Free Stock Analysis ReportFCB Financial Holdings, Inc. (FCB): Free Stock Analysis ReportSPDR-FINL SELS (XLF): ETF Research ReportsSPDR-KBW BANK (KBE): ETF Research ReportsTo read this article on Zacks.com click here.Zacks Investment Research