Banks are the sweet spot of this market that’s about to get a lot tougher

Investors are gravitating toward a new favorite part of the stock market, which seems to have just about everything going for it right now: banks.

The sector is nipping on the heels of the technology sector, which has been the best performer since the 2016 presidential election, as investors bet that higher rates, lower taxes, deregulation— not to mention a return to market volatility favorable for investment banks — will keep lifting the industry’s profits.

“We’ve been increasing our weight in financials and banks for several reasons: The banks have repaired their balance sheets; financials are trading at attractive valuations; we still think banks are underowned since the financial crisis, they’ll benefit from deregulation; and interest rates are going up,” said Ernie Cecilia, CIO at Bryn Mawr Trust.

From the 2016 presidential election through Thursday, the S&P 500 technology industry is up 46 percent, but financials are just behind with a 45 percent gain.

Interest rates have surged to multiyear highs recently as inflation shows signs of life. The consumer price index — a widely followed metric of inflation — rose 0.5 percent last month, topping a Reuters estimate of 0.3 percent. On Thursday, the benchmark 10-year note yield hit its highest level in four years.

The move higher in rates sent jitters through Wall Street recently. In the 10 previous sessions, the S&P 500 has posted eight moves greater than 1 percent. For context, the broad index posted only eight 1 percent moves all of last year.

But financials, particularly the big banks, benefit both from higher interest rates and volatility. Higher rates let banks increase lending rates and make it more attractive for people to deposit cash in bank accounts. They also increase the profitability of insurance companies, which sell interest-rate sensitive products.

“You’re probably going to see financials improve,” said Maris Ogg, president at Tower Bridge Advisors. “There’s no question that as rates rise their margins will continue to widen.”

The sector has bounced back 6.9 percent since the S&P 500 closed in correction territory on Feb. 8, or down 10 percent from an all-time high set last month. The broad index, meanwhile, is up about 5.8 percent since then.

“Financials have drawn the attention of everyone,” said Robert Pavlik, chief investment strategist at SlateStone Wealth. “Interest rates are on the rise.”

Pavlik said he was a buyer in the group during the market’s downturn, noting Bank of America is one of the stocks he bought in that time.