This was a strange and historic year for the financial sector. Traditional banks including Wells Fargo and Goldman Sachs saw their shares rebound strongly in 2021, while high-flying fintech players like Block and PayPal sagged on growth concerns. Smaller institutions like U.S. Bancorp and Citizens acquired rivals in a push to scale up their operations, resulting in more than $58 billion in bank mergers, the biggest annual total since the financial crisis. Investors poured more than $94 billion into private fintech companies, a record level and double the 2020 mark, helping to inflate the value of massive start-ups like Stripe, Chime and Revolut . Some of the new players began trading publicly for the first time, including Robinhood and Coinbase . The boundaries between traditional banking and crypto also blurred, as old-school players like Goldman and Morgan Stanley began to dip their toes in the asset class for the first time , while a parallel universe of blockchain-enabled transactions dubbed decentralized finance grew by leaps and bounds. Most of these trends are expected to carry into next year, driven by the industry's need to digitize itself, competition with fintech disruptors and investors' search for yield. But the single biggest factor for the industry is the Federal Reserve's expected push to tighten monetary policy and fight inflation by raising interest rates. That's made analysts bullish on the industry as a whole because bank profit margins tend to expand when rates rise. Here are some of their highest-conviction picks for 2022: Wells Fargo Banks are the stocks most correlated to interest rates and have outperformed other industries during rising rate periods, according to veteran analyst Betsy Graseck of Morgan Stanley. With expectations that the Fed will hike rates as many as three times next year, banks are expected to reap the benefits. Wells Fargo, the fourth-biggest U.S. lender by assets, is the most rate sensitive of large banks, Graseck said. The analyst upgraded the banking giant this month to overweight and named it one of her top plays. "Wells is in a strong position to monetize higher rates, as cash stands at 15% of earning assets, 7% points above pre-pandemic levels," Graseck said in a Dec. 6 note. "This provides latent fuel for loan growth and securities reinvestment." Wells Fargo is also the top pick of Deutsche Bank analyst Matt O'Connor, who expects earnings per share to jump 25% to 30% over the next two years. The bank is in the "latter stages" of addressing U.S. regulators' concerns sparked by the bank's 2016 fake account scandal, O'Connor said. Bank of America Meanwhile, analyst Vivek Juneja of JPMorgan prefers Bank of America as a beneficiary of higher rates. Like Wells Fargo, Bank of America has a huge share of U.S. deposits, thanks to its vast network of branches and well-regarded mobile banking products. The analyst expects that two interest rate increases next year will boost 2023 earnings per share by a median 4.1% among covered banks, but that Bank of America will see a 5.1% earnings boost. Bank valuations are cheap relative to the S & P 500, thanks to the impact of technology companies in the benchmark. Juneja has a price target of $50 per share on the stock. That's about 12% the stock's current level. Charles Schwab Retail brokerage Charles Schwab is the top pick among asset managers covered by Deutsche Bank analyst Brian Bedell, who expects 2022 will feature the sector's strongest stock performance of recent years. The brokerage has seen assets under management balloon during the last two years, but revenue has been hampered by low interest rates. Charles Schwab's margins will improve as rates rise because it is among the most sensitive to both the short and long end of the rate curve, according to Bedell. The analyst sees an upside of nearly 50% for Schwab over the next 12 months. Capital One Capital One is trading close to its valuation floor just as loan growth is about to pick up, according to Graseck. Concerns about credit quality are overblown and bank management is well positioned to expand the customer base in credit cards, she wrote. "We see today's valuation as a big opportunity for investors to gain a very attractive entry point into COF," Graseck said. The bank is "driving some of the strongest card loan growth out of all peers recently" at 5% year over year. Graseck's $221 per share price target implies a more than 60% upside from current levels. U.S. Bancorp U.S. Bancorp is rated overweight by JPMorgan's Juneja, who noted that the Minneapolis-based lender gets a higher-than-average share of revenue from credit cards, especially areas impacted by Covid-19 like travel. The bank should therefore benefit more than other lenders as consumer spending normalizes and the impact of the omicron variant fades, Juneja wrote. Deutsche's O'Connor also likes U.S. Bancorp, citing an expected 8% boost to EPS from the firm's acquisition of MUFG Union Bank. JPMorgan has a price target of $73 per share on U.S. Bancorp, roughly 29% above current levels. Ally Another one of Graseck's favorite picks is Ally, a Detroit-based online lender. The company's stock has been hit by concern that elevated used car valuations will suddenly deflate, but the company's low valuation makes it attractive, she said. Ally's valuation equates to expectations for a 12% return on capital, well below the 17% expected by the analyst by 2023. "Ally stands out as a distinctively attractive opportunity given its 5.6x P/E on 2023e EPS, an outlier relative to its increasing net interest margin," Graseck said. "The market seems to have forgotten that its funding model has shifted to deposits, which comprises ~90% of its funding today." Block Shares of Block, the Jack Dorsey-led fintech firm formerly known as Square , have declined about 25% this year as some high-flying tech names have sunk to earth. But Block is among the best positioned to reap the rewards from several fintech trends, according to BTIG analyst Mark Palmer, who calls it the most compelling pick in his coverage universe. The company has a lead among digital players jockeying to become the one-stop shop for retail banking needs, has had success targeting the unbanked and underbanked, and will likely play a role in further mainstreaming crypto and DeFi, Palmer wrote in a Dec. 1 note. Block's recent $29 billion acquisition of Afterpay gives it a foothold in the hot buy now, pay later segment, and its industrial banking charter gives it a funding advantage versus other fintech players, Palmer said. The company's merchant and retail banking products have strong momentum into 2022, according to KBW analysts led by Sanjay Sakhrani. The analysts said the sector's recent stock pullback is a "an opportunity to enter the name at a more attractive valuation." Mastercard The recent sell-off in payments companies has left the industry "more attractive than they have been in a long time," according to KBW. Payment networks like Mastercard and Visa are now trading at a 20% to 30% discount to historic multiples, the analysts said. Within the space, payment network Mastercard is preferred over Visa because the former has more exposure to cross-border and international transactions, KBW said. That activity should recover as pent-up demand from consumers leads to a rebound in travel, the analysts said. Coinbase Oppenheimer analyst Owen Lau named Coinbase a top pick among exchanges because it stands to benefit from the mainstreaming of digital assets, the development of DeFi protocols and increased mergers in the space, he wrote in a Dec. 22 note. Lau believes that, just as in 2021 and 2020, more institutions will allow users to buy, sell and hold bitcoin and other digital assets, and institutional investors will continue to adopt the asset class. "For institutional investors who are interested in getting exposure to digital assets, we believe COIN is well positioned to benefit from it," Lau said. "We are still in the early innings of this development, and we believe many investors are still on the sidelines."
Wells Fargo signage on May 5th, 2021 in New York City.
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