Key Points
There’s a misconception that rising interest rates are a negative for U.S. stocks. In reality, it’s a little more complicated than that. Higher rates affect different industries differently.
One sector that could get a tailwind is financials. Higher interest rates can actually improve their financial health, which is why I’d be looking to add the State Street Financial Select Sector SPDR ETF (NYSEMKT: XLF). But rates aren’t the only thing it has going for it.
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Financials have several ways they can win
The case for this sector really begins with the Federal Reserve’s path for interest rates. This month, it raised the fed funds rate by 25 basis points to a range of 3.75%-4%. The fed funds futures market is currently pricing in roughly 75 basis points of additional hikes by the June 2027 meeting.
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Banks can benefit from higher interest rates when the spread between what they earn on loans and what they pay on deposits widens. That difference improves net interest income and translates directly to the bottom line. A steeper yield curve can also help with this.
In that rate hike, the focus was obviously on inflation. But the Fed also indicated slightly higher growth expectations in 2027 and resilience in domestic spending. This gives the central bank potentially more room to raise rates without immediately raising recession risk. This would be a bullish catalyst for the financials sector.
Analysts at Charles Schwab also recently noted in their sector outlook that this sector is “seeing upward earnings revisions from a steeper yield curve and solid net interest income, as well as improved capital markets activity.”
Valuations for financials are attractive, too
The Vanguard S&P 500 ETF (NYSEMKT: VOO) currently trades at a forward price-to-earnings (P/E) ratio of 20. That’s come down from its recent peak, but valuations remain a concern for investors. And it’s a major reason value stocks are outperforming growth by a wide margin this year.
The State Street Financial Select Sector SPDR ETF trades at only a little over 15 times forward earnings, making it a much better value than tech or the broader market. Earnings growth for the sector is expected to be 15% in 2026 and another 8% in 2027, making it a relatively reasonable value at current prices.
Today’s opportunity in financial stocks
As long as economic growth remains at least good, and corporate earnings and GDP growth suggest it is right now, the financials sector looks primed to keep moving higher. The macro backdrop is favorable, valuations are reasonable, and earnings are growing at a solid pace.
I think it’s one of the more attractive opportunities in the market today.
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Charles Schwab is an advertising partner of Motley Fool Money. David Dierking has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard S&P 500 ETF. The Motley Fool recommends Charles Schwab and recommends the following options: short September 2026 $95 calls on Charles Schwab. The Motley Fool has a disclosure policy.
