According to the sector rotation investment strategy, bank stocks are hot buys just as an economy comes out of recession and starts to get comfortable. Why? The answer is largely due to the lower interest rates that banks are adept at using to sell mortgages, but also because of the level of security of reliable profits that equity investing in banks affords the investor.
But bank stocks do not sit on the sidelines after the recession is over and the bull market commences. After the economic turmoil of 2008, American mega banks Bank of America (BAC), Wells Fargo (WFC), and Goldman Sachs (GS) took less than a couple months to reach double or triple their trading prices off the lows. The past two months has seen some American banking stocks reach new highs unseen since the Credit Crisis. Rising bond yields this month has naturally helped the growth along. But how will bank stocks react when the Feds finally decide to raise the prime lending rate? Can they utilize higher rates the same way they do lower rates?
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Some analysts believe that the bull market is forthcoming, while others believe that the markets will give in to global turmoil, plunging us into another recession. The impending answer is actually not as decisive as an investor’s naked eye might make it out to be for bank stocks. Even in a negative market situation, a raise in the prime rate would benefit the banks’ assets more than it affects their liabilities. This is because the banks are currently asset sensitive. Despite not reaping the massive profits that prevailed in the mid 2000’s, banks have still accumulated massive assets. Raising rates will be more beneficial for Bank assets than the negative effects on liabilities. Additionally, of course, higher borrowing rates would not halt borrowing (quite the contrary) and banks find themselves in a great position to reach higher profit levels and ratios in a bull market. There is good reason that financial institutions are situated as a good buy during the very beginning of an economic upturn in the sector rotation strategy. Using banking stocks to hedge your bets against either direction the economy moves can prove to be a nifty and resourceful strategy for beating the S&P, which is what the KBW Bank Index has been doing with ease all year.