Banks are still one of the most-hated sectors in the world.
According to a recent Gallup poll, just 33% of consumers said they have a positive view on banks.
This is not all that surprising.
During the 2008-’09 credit crisis, banks were one of the worst-hit sectors. In an effort to generate more profits, banks began lending money to unqualified borrowers (subprime loans). In 2008, the financial sector nearly shut down as most people walked away from these loans.
Of course, this is the short version of what took place during the credit crisis. But banks were secretly adding more risk to their balance sheets. And most of the world — including our regulatory authorities — knew little about it.
In the end, most of these banks needed cash infusions. Without these injections from our government, several big companies in this sector may have fallen into bankruptcy. That includes heavyweights like Citigroup (C) and Bank of America (BAC).
Today, most people still have a negative opinion on banks. However, this shouldn’t discourage investors from buying some of the large banking stocks. After all, they are likely to see huge gains over the next 12 months as the Federal Reserve begins to raise interest rates.
Let me explain …
Rising interest rates are widely viewed as a negative for stocks. Borrowing costs for consumers and businesses are moving higher. Plus, higher interest rates could persuade investors to move their money out of stocks and into interest-paying alternatives.
But higher interest rates are great for bank stocks. That’s because the spread between the cost to borrow money and the actual rates banks can charge their customers widens.
You see, banks have plenty of cheap money at their disposal. (The average interest rate on a savings account, for example, is about 0.26% right now). But with interest rates rising, banks can lend that money back out at much higher rates — in a mortgage at 4%, for example.
The higher those rates go, the wider the spread gets … and the bigger the banks’ profits.
In fact, banks will be the first to tell you how rising rates will be great for their bottom line. They write about it in their annual reports.
For example, JPMorgan (JPM) said it would generate nearly $3 billion in additional net income if rates rise by 1%. Bank of America said a similar increase in rates would lead to nearly $4 billion in additional net income for the company.
To put these billions in perspective, this would amount to a 14% increase in net income for JPMorgan and a 27% increase in net income for Bank of America. This is based on the net income these companies generated over the past 12 months.
To play this banking trend, you can buy JPMorgan and Bank of America today. These names are dirt-cheap, have strong balance sheets and are likely to raise their dividends going forward. With interest rates expected to rise over the next 12 months, these individual stocks should easily outperform the market.
Another good way to play this trend is to buy the Financial Select Sector SPDR Fund (XLF). Its top holdings include some of the biggest banks in North America. The yield on XLF is 1.8%, which is slightly higher than the average S&P 500 company.
Rising interest rates are almost a given for 2016. The best way to make money from this trend is by adding some financial exposure to your portfolio right away.