Financials are one of the best performing sectors in the S&P 500 this year, and some Wall Street strategists say the banks will continue to outperform, given improving loan fundamentals, attractive valuations and rising dividends.
So far this year, financials have gained 21 percent, which is the second best performing sector. Last week, the financials climbed the most of any sectors, rising 3.7 percent, and they were one of the best performing sectors Monday, making gains while most sectors declined.
Jonathan Golub of UBS, in a recent research note, argued that this sector will continue to outperform. For one, the sector boasts improving loan fundamentals including rising volumes and a steeper yield curve. Secondly, the sector is attractively valued: financials trade at 1.24 times book value, which is a discount to their historical average of 1.86.
Also, during the most recent earnings seasons, financials posted the highest year-over-year earnings growth of all sectors – 18 percent versus the rest of the market at 0.8 percent. Even after excluding J.P. Morgan, Bank of America, Citigroup, Goldman Sachs and Morgan Stanley, financials earnings growth clocked in at 9.5 percent.
Finally, during the downturn, banks were forced to cut or eliminate their dividends but now, Golub says, U.S. banks are now generally in good health and will continue returning capital to shareholders.
"This should make the group more attractive to yield-oriented investors," Golub wrote.
Pete Najarian of optionmonster.com points out that there's consistent upside bias to call options on financials, especially Citigroup, JP Morgan and Bank of America as traders position for more gains. Najarian notes that, on May 17, of the 300,000 total options traded in Bank of America, 226,000 were calls.
Najarian, a CNBC contributor, has been bullish on the financials since last November, and he continues to favor the sector.
Not everyone is a fan of the financials, however. Dr. Komal Sri-Kumar, president of Sri-Kumar Global Strategies and former chief global strategist of TCW, remains defensive, and underweight the financials.
He says the U.S. economic outlook is still mixed as evidenced by the disappointing data last week on jobless claims and the Philadelphia Fed survey. He adds that there is very little U.S. inflation, a signal of weak overall demand.
The strategist also says that major US banks have exposure both to European sovereigns and to European banks.
"The impact of a further deterioration in the European debt situation on U.S. banks is not yet fully in the price," he tells CNBC. "I am expecting haircuts on banks imposed by even larger European countries such as Italy and Spain after the conclusion of Germany's national elections on September 22."
Sri-Kumar says U.S. banks may ultimately have to take write-offs which, in turn, would require capital raising to bring capital back to adequate levels.