The Fed with a clear majority decided to keep interest rates unchanged at the end of its latest two-day policy meeting this month. However, the Fed sees a near-perfect economic environment to keep gradually increasing rates.
Market watchers, moreover, believe that the Fed’s latest policy statement indicates that a near-certain rate hike in December. Further, three more rate hikes are likely in 2019. Given this backdrop, mutual funds with significant exposure to the financial sector are expected to be strong investments as the key interest rate is likely to march higher in the near future.
December Rate Hike Possibility Increases
At the end of its two-day policy meeting, the Federal Reserve kept the target range for the federal funds rate unchanged at 2-2.25%. However, it stated that “further gradual increases” would be needed given the current pace of economic growth, strong labor market conditions and the Fed’s inflation target of 2%.
Most investors put chances of the Fed hiking rates by 0.25% in December at 80%. This inference is being drawn from the central bank’s September dot plot. Per this forecast of interest rate projections, most Fed officials predict that the funds rate will be 0.25% higher by the end of 2018. The central bank has already hiked rates thrice this year.
Annual Wage Growth Best Since Recession, Q3 GDP Advances
The Fed did mention that “economic activity has been rising at a strong rate and that labor market has continued to strengthen,” which could easily offset concerns about soft spots in the economy.
Average hourly earnings rose by 0.2% or 5 cents to $27.30 in October, in line with the consensus estimate. Over the year, it has advanced 3.1% or 83 cents, increasing more than 3% for the first time since mid 2009. The unemployment rate remains flat at the lowest level since December 1969. Further, the economy added 250,000 jobs in October, significantly higher than the consensus estimate of 193,000.
In the last two quarters, the U.S. economy recorded the fastest six-month growth in four years and is on track to hit the Trump administration’s annual growth target of 3%. In the third quarter, U.S. GDP increased at an annualized pace of 3.5%, per the U.S. Commerce Department.
How Does a Rate Hike Benefit Financials?
A high rate environment bodes well for financial companies including banks, money managers, insurance firms and brokerage companies. Banks derive benefits from a steep yield curve, i.e. when the spread between long-term and short-term rates widens. This means that the potential rise in rates will enable banks to charge more for loans, leading to an increase in the spread between lending rates and the rates paid on deposits.
Also, rising rates reflect an improving domestic economy. Higher economic growth attracts more investment, which in turn is expected to benefit brokerage firms and money managers. For insurance companies, a high rate environment ensures that their underlying bond investments provide strong returns.
Buy These 4 Financial MutualFunds
The financial sector performed favorably in recent times following the Fed’s interest rate hikes and strong job growth. Market watchers believe that this rally will continue if rates march higher even in 2018. Financial Select Sector SPDR (XLF) has advanced 3.7% in the last one-year period. According to Morningstar, the financial mutual fund category has posted one-year returns of 2.3%.
This encouraging backdrop warrants investor focus on four financial mutual funds that boast a Zacks Mutual Fund Rank #1 (Strong Buy) or 2 (Buy). Moreover, these funds have impressive year-to-date (YTD) returns. They also have minimum initial investment within $5000 and low expense ratios.
We expect these funds to outperform their peers in the future. Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but also on the likely future success of the fund.
T. Rowe Price Financial Services (PRISX - Free Report) seeks both capital growth and current income. The majority of its assets are invested in financial services sector companies. It may also purchase securities of companies involved in providing financial software. The fund uses fundamental bottom-up analysis to select securities.
The fund has three-year annualized returns of 9.7% and an expense ratio of 0.85% compared with the category average of 1.40%. PRISX has a Zacks Mutual Fund Rank #2. Moreover, PRISX requires a minimal initial investment of $2,500.
Davis Financial A (RPFGX - Free Report) uses Davis Investment Discipline to invest a minimum of 80% of its assets in securities issued by companies involved mainly in the financial services sector. These companies own financial services-related assets that are more than 50% of the value of total assets or earn a minimum of 50% of revenues from offering financial services.
The fund has three-year annualized returns of 9.4% and an expense ratio of 0.98% compared with the category average of 1.40%. RPFGX has a Zacks Mutual Fund Rank #1. Moreover, RPFGX requires a minimal initial investment of $1,000.
Prudential Jennison Financial Services A (PFSAX - Free Report) seeks capital growth for the long run. PFSAX invests a huge portion of its assets in equity securities of asset management companies, securities/brokerage firms, mortgage banking companies, banks, insurance companies, industrial finance companies and leasing companies.
The fund has three-year annualized returns of 5.9% and an expense ratio of 1.34% compared with the category average of 1.40%. PFSAX has a Zacks Mutual Fund Rank #1. Moreover, PFSAX requires a minimal initial investment of $2,500.
Fidelity Advisor Financial Services A (FAFDX - Free Report) invests the majority of assets in securities of companies engaged in providing financial services to consumers. FAFDX invests in domestic and foreign issuers. The fund seeks appreciation of capital.
The fund has three-year annualized returns of 9.4% and an expense ratio of 1.10% compared with the category average of 1.40%. FAFDX has a Zacks Mutual Fund Rank #2. Moreover, FAFDX requires a minimal initial investment of $0.
Want key mutual fund info delivered straight to your inbox?
Zacks’ free Fund Newsletter will brief you on top news and analysis, as well as top-performing mutual funds, each week. Get it free >>