Cyclical stocks have come to life as market rotation is in full swing. And I like financial sector stocks best - these two in particular.
The vaccines are being distributed. In the next several months, the remaining lockdowns and restrictions should be lifted, at least mostly. That will unshackle the economy into a full recovery that most economists predict will deliver the best GDP growth in decades this year.
In case that isn’t enough, there are also trillions of dollars in stimulus floating around, and maybe even more on the way. And interest rates are still low. A booming economy, oodles of cash all over the place, and low interest rates are combining to make an excellent environment for stocks, particularly the previously downtrodden cyclical companies.
Cyclical stocks have been on fire. The Financial Select Sector SPDR Fund (XLF), which represents the financial sector of the S&P 500, is up 44% since the vaccine announcement in November. The Energy Select Sector SPDR Fund (XLE) has soared a stratospheric 73% over the same period. There have also been impressive rallies in travel and leisure stocks, materials, industrials and retail stocks.
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The Main Street economy sectors were hurt the worst by the lockdowns during the pandemic. And they have the most to gain by the re-opening. The market loves industrial-strength rebounds. Despite the recent stellar performance, many of these stocks are still below pre-pandemic prices and should have more upside ahead of a very promising environment.
Of the re-opening beneficiaries, I like the financial sector best. Financial stocks stand to benefit in a full recovery as economic activity picks up and there is more money to invest. As well, banks and other financial companies benefit from higher interest rates. And rates are still well below pre-pandemic levels and are all but certain to rise in a booming economy. In fact, rates are rising already.
But this sector should have a longer-term rebound as well. Financials stocks didn’t just get beaten up by the pandemic; that sector has been on the outs for most of the last 14 years. It was at the epicenter of the financial crisis. Stocks were slaughtered in that bear market and then had to contend with a regulatory onslaught and investor skittishness.
Consider what a poor bull market this sector had last time around. The S&P 500 Index eclipsed the pre-financial crisis 2007 high in 2013. The XLE just surpassed the 2007 high last month. The SPDR S&P Bank ETF (KBE) is still below the 2007 high.
This sector should have a much better bull market this time around, and we are in the very early stages. Banks and other financial sector stocks are well positioned not only for a further rebound over the rest of this year, but a secular rebound as well. These stocks look good for both the near term and beyond.
Here are two good financial stocks to consider.
Financial Sector Stock #1: U.S. Bancorp (USB)
Yield 3.1%
U.S. Bancorp (USB) is the fifth-largest bank in the United States and the country’s largest regional bank with over 3,000 bank branches in 25 states in the western and northern U.S. The Minneapolis bank was founded in 1863 and now has more than 70,000 employees and $543 billion in assets.
Regional banks are highly dependent on net interest income, the spread earned between the cost of borrowing money and the loan rate charged. Banks borrow as short-term rates set by the Fed are likely to remain near 0% for the foreseeable future. At the same time, longer-term rates are rising and should continue to rise as the recovery gains traction. The steeping yield curve is great for banks.
The stock is also cheap. Although USB is up about 17% YTD, it still sells below the pre-pandemic price ahead of an environment that is likely to be much better for banks. It also sells at valuations well below the overall market.
But it’s mostly about the trend. USB has been trending higher since last September. The early part of a recovery is a great time for banks and financial companies and USB should continue to thrive into the full recovery later this year.
Not only does USB still sell at a compelling valuation, but it has momentum. Momentum boosts the level of call premiums.
Financial Sector Stock #2: KKR & Co. Inc. (KKR)
Yield 1.2%
KKR & Co. (KKR), Formerly Kohlberg Kravis Roberts Co., is a leading global alternative asset manager. The firm manages multiple alternative asset classes including private equity, energy, infrastructure, real estate, credit, as well as hedge funds through strategic partners. It generates revenues from management fees, performance income and investment income with a global reach on five continents.
KKR is also the best player in a massive growth trend in the wealth management industry. Alternative investing is absolutely booming.
Basically, alternative assets are those that do not fall within the realm of traditional stock and bond market investments. In the world of high finance, these assets include areas such as private equity and hedge funds among other things.
These investments are growing like crazy. Global alternative asset investments have grown from $6.4 trillion in 2012 to about $14 trillion in 2020. It is estimated that alternative assets worldwide will continue to grow to more than $21 trillion by 2025.
There’s a good common-sense reason for the growth. Consider your own investment situation. Bonds are low paying and treacherous. The only place to fetch a decent return in the stock market. But it’s risky to have a huge portion of your nest egg in the market.
It’s an even bigger problem for high-net-worth individuals, and most especially for institutions like pension and endowment funds with fiduciary responsibility. They need to manage risk and diversify away from the market and get a decent return at the same time. Alternative assets are just what the doctor ordered.
I consider KKR to be the best of its peers in the sector. It has blown away the return of its competitors over the past five years, averaging an annual return of 35.9% over the last five years and 36% over the last three. And there are good reasons to believe the outperformance will continue.
All the tell-tale signs of good future performance are there in droves too. Assets under management broke the all-time record this past year, as has funds invested in the fourth quarter. And the firm still has plenty of dry powder going forward. KKR also made a big acquisition last year that should be very accretive to earnings this year.
Despite the recent stellar performance, KKR still sells at a price/earnings ratio of less than 14. That’s well below the five-year average and less than half of the current S&P 500 price/earnings ratio.
The stock has moved sideways for the last six weeks after a big surge and could be consolidating ahead of another move higher in the weeks ahead.
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