Fresh rhetoric on North Korea ruined market gains on Tuesday as the Dow’s record run of wins finally came to a close. Despite the day’s gyrations between loss and advances, trading retained a muted tone, with the S&P 500 losing only 0.2% to end near session lows.

Such a finish was in keeping with the market’s mood over most of the year, with the broadest benchmark hovering within an extremely narrow corridor. And despite losing out on early gains to end the day 0.2% lower, financials may hold the key to gains in the days ahead. A variety of factors have investors rooting for the group and you would be missing out on some neat profits if you don't pick up these five great financials picks. 

Trading Within a Tight Band

By all accounts, this has been the quietest stretch of trading since 1965. One estimate puts the current level of volatility at the lowest in 52 years. Since Jul 19, the S&P 500 has not gained or lost 0.5% over a single session. In fact, the index has swung 1% either way only four times year to date. The only exception to such placid behavior has been the Nasdaq, which has moved 1% over 11 trading days.

To put things in perspective, the market’s so called “fear gauge”, the VIX, continues to linger near its lowest point in 23 years and more. The popular measure of market volatility had plummeted to this level on May 8, within striking distance of where the market stands. Of course, this has translated into strong gains for the average investor, with the S&P 500 up more than 9% year to date.

Not just that, indexes have continued to notch up record levels during this abnormally quiet stretch of trading. The calm has been broken only seldom, primarily by the valuation fears which stalked tech stocks before their fabulous second-quarter results.

Could a Dip be Around the Corner?

But growing voices within the investment community believe that such a state of affairs might not last long. Even as friction with North Korea rises, central banks across the world are taking a hawkish stance on monetary policy. Meanwhile, there are growing signs that the projected step up in GDP, to 3%, is unlikely to happen during a likely lackluster second half. This is another reason why upside has been limited for stocks till now this year as investors continue to steel themselves for the drop that is likely to come sooner or later.

Even as the future looks uncertain for markets, investors are becoming increasingly partial to a few select sectors and to financials in particular. According to Wells Fargo & Company (WFC Quick QuoteWFC - Free Report) , this is one of the sectors presently positioned “for the biggest outperformance."

Why Financials are Set to Win

A bunch of fundamental and technical factors have been working in the sector’s favor. Investment firm Oppenheimer has underlined the fact that finance has remained the leading sector in terms of performance since May, even as interest rates plummeted and Treasury yields touched peak levels. Strong performance in the face of such adverse conditions was a sign that downsides had been priced in and the sector was set to rally, the firm said.

Additionally, the sector remains relatively undervalued at a time when prospects of further deregulation look bright. The Goldman Sachs Group, Inc. (GS Quick QuoteGS - Free Report) strongly believes share buybacks and dividends for the sector are likely to rise thrice as much as that of the S&P 500. Further, the investment bank thinks even though finance has gained more than 30% over the last year, emerging as the best performing sector, room for further upside still exist.

Our Choices

Stocks have traded within a narrow channel so far this year, continuing to create multiple milestones. But such tight trading hints at futher downside. In such a scenario, a few favored sectors have emerged and finance is likely the most promising of them all.

Picking financials, the leading performer over the last one-year period, will help you reap rich profits even in the near term. However, picking winning stocks may be difficult.

This is where our VGM score comes in. Here V stands for Value, G for Growth and M for Momentum and the score is a weighted combination of these three scores. Such a score allows you to eliminate the negative aspects of stocks and select winners. However, it is important to keep in mind that each Style Score will carry a different weight while arriving at a VGM score. 

We have narrowed down our search to the following stocks based on a good Zacks Rank and VGM score.

LPL Financial Holdings Inc. (LPLA Quick QuoteLPLA - Free Report) is engaged in providing an integrated platform of brokerage and investment advisory services to independent financial advisors and financial advisors at financial institutions in the U.S.

LPL Financial has a Zacks Rank #1 (Strong Buy) and a VGM Score of A. The company has expected earnings growth of 23.2% for the current year. Its earnings estimate for the current year has improved by 6.6% over the last 30 days. LPL Financial has gained 72.1% over the last one-year period.

FS Bancorp, Inc. (FSBW Quick QuoteFSBW - Free Report) is a holding company of 1st Security Bank of Washington that delivers banking and financial services to local families, local and regional businesses and industry niches within distinct Puget Sound area communities.

FS Bancorp has a VGM Score of B. The company has expected earnings growth of 13.4% for the current year. Its earnings estimate for the current year has improved by 16.2% over the last 30 days. FS Bancorp has gained 63.1% over the last one-year period. The stock has a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here . 

American Equity Investment Life Holding Company (AEL Quick QuoteAEL - Free Report) through its wholly owned operating subsidiaries is a full service underwriter of a broad line of annuity and insurance products, with primary emphasis on the sale of fixed rate and index annuities.

American Equity Investment Life has a Zacks Rank #2 (Buy) and a VGM Score of A. The company has expected earnings growth of 72.7% for the current year. Its earnings estimate for the current year has improved 4.3% over the last 30 days. American Equity Investment Life has gained 78.4% over the last one-year period.

CNO Financial Group, Inc. (CNO Quick QuoteCNO - Free Report) is a top-tier holding company for a group of insurance companies operating throughout the U.S.

CNO Financial has a Zacks Rank #2 and a VGM Score of B. The company has expected earnings growth of 7.9% for the current year. Its earnings estimate for the current year has improved by 5.8% over the last 30 days. CNO Financial has gained 55.7% over the last one-year period

Bank of Commerce Holdings is a holding company of Redding Bank of Commerce that delivers a large number of financial services and products to individual as well as small and medium business customers in California.

Bank of Commerce has a Zacks Rank #2 and a VGM Score of B. The company has expected earnings growth of 61.5% for the current year. Its earnings estimate for the current year has improved by 3.3% over the last 30 days. Bank of Commerce has gained 55.1% over the last one-year period.

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