Supercharged by prospects of a regulation rollback under the new administration and higher interest rates, the financial sector has been on fire since the November election. In a sharp turnabout from more than a year in the doldrums, financial stocks have surged more than 15% since Election Day as compared with the Standard & Poor’s 500 index, which is up less than 6% in the same period. The financial sector has led all sectors by more than double with a nearly 20% gain over the last three months. After several years of struggling through a low interest rate environment and heavy regulatory scrutiny, the pieces may be falling for a strong performance for the financial sector and, along with it the strong possibility of dividend increases in 2017.
The performance of the financial sector since the 2008 financial crisis has been choppy at best. It is the only sector to show a negative overall return over the last ten years. If you owned financial stocks during that period, you were either a hopeless optimist thinking the economy would suddenly surge, or you like stocks that pay good dividends, regardless of the state of the economy. Now might be the right time to reconsider financial stocks for both reasons.
It Has Been a Rough Ride for Financial Stocks
Financial stocks have been under pressure ever since interest rates fell to near zero. Although the lower rates were supposed to encourage more borrowing, banks can’t make money when interest rates are that low. So, for the last eight years, profit margins have been thin with most of the revenue coming from fees. However, consumers and regulators have also focused on fees. Fake accounts, bank complaints, and hefty fines has kept the financial sector on its toes. With little hope of growing profits, most bank stocks underperformed the stock market which has been on a record tear since the crisis. The only consolation for investors has been the dividends paid by banks, which have always been among the higher dividends paid by companies. Although most banks continued to pay dividends during this period of underperformance, many had to reduce their payout.
Time for a Turnaround
After years of reducing their risk and increasing their cash positions, banks are poised to enjoy their strongest year in a decade. Consumers and companies have largely deleveraged over the last eight years which means the appetite for borrowing is increasing. Mortgage demand is also picking up, especially as the threat of higher rates emerges. On a macro level, banks can expect a loosening of regulations which will reduce their costs. The yield curve is finally starting to correct itself growing steeper with the prospect of higher long-term interest rates. The stage has been set for higher profits and, with them, higher dividends.
Ready for Dividend Hikes
Although most stocks in the financial sector have been run up in the recent stock market rally, there are still good buying opportunities, especially when you consider the dividend yields of these stocks. One of the advantages of buying stocks with strong dividends is they provide a cushion against falling stock prices. In effect, the dividend compensates you while you ride out the declines in the market. Right now, the sector offers up some very attractive dividend opportunities, such as Wells Fargo (NYSE: WFC).
Although its stock price is near its 5-year high at around $55 a share, Wells Fargo’s dividend is yielding 2.75%, which is well above the dividend yield of the S&P 500 index and still above the long-term Treasury bond yield. BB&T (NYSE: BBT) is a strong performing regional bank with a strong dividend history, currently yielding 2.6%. Both banks have indicated they will resume their dividend increases this year, and many others are expected to follow suit.