With the recent collapse of the Silicon Valley Bank and the Signature Bank, among other failures and difficulties in the sector such as with Credit Suisse and Deutsche Bank, the financial services sector has been in the spotlight. Many investors are therefore wondering: is this sector a promising market to invest in? What are the risks of investing in the financial services sector? What are its advantages and growth opportunities? How can you best profit from this industry if you decide that it’s a good investment opportunity? Let’s dive right in!
What is the financial services market?
The financial services market encompasses a diverse array of businesses and institutions - such as banks, stockbrokers, insurance companies, lending companies, financial advisors, investment firms, and other similar firms, which offer a wide range of financial products and services, mostly to individuals, businesses, and governments.
The market is essential to the global economy by facilitating the flow of capital and providing access to various financial products and services, such as savings and checking accounts, loans, credit cards, insurance policies, investment products, and financial advice about tax preparation and planning, as well as accounting for instance.
State of the financial services market
Throughout most of 2022, the financial sector experienced a decline, along with the rest of the market. However, towards the end of the year, the sector outperformed the broader market.
Rising interest rates can increase bank profitability by widening the gap between the income they earn from loans and the interest they pay on deposits. But while credit performance has remained relatively strong, concerns of a potential recession in 2023 intensified in late 2022. Banks have been preparing for this possibility by setting aside capital to cover potential losses on upcoming credit defaults - and this amount keeps increasing.
If banks are being conservative in allocating capital for loan defaults, it could imply that they are in a stronger position than what market participants perceive. Even if banks have improved their financial health since the crises we’ve seen over the last decades, some investors still appear to hesitate to invest in the sector. Financials were, for instance, among the cheapest sectors of the S&P 500 index as of late 2022 and also comparatively cheap in relation to the sector's own historical valuation trends.
Putting aside money to protect themselves against payment defaults may work in their favor as they would be better equipped to navigate through different economic situations that may arise and profit from any future rebound or extension of the present economic cycle at the same time.
Financial services market - What are the growth opportunities?
If you consider all the subsectors of financial services, there are many growth opportunities you can take advantage of, depending on what the state of the sector is when you decide to invest, its overall growth prospects, as well as its geographical focus and the technological advancements at the time.
Here are some ideas supporting the growth of this sector:
- Rising interest rates (allowing higher net interest from banks and lending institutions)
- Sustainable and green finance (investment opportunities with Environmental, social and governance (ESG) and Socially responsible investing (SRI) for instance)
- Digital currencies and blockchain (development of cryptocurrency-related and blockchain-based products and services)
- Emerging markets (especially for some sub-sectors of the financial services sector like insurance companies, banking, or investment banking services)
- All technologies helping companies to make better decisions about investment opportunities, risk assessments, and pricing among others (artificial intelligence, machine learning, big data analytics, blockchain, etc.)
- Development of the online and mobile banking
- Higher demand for personalization in the banking, insurance, and investment-related services and products
- Stronger demand for alternative financial products
What are the risks of investing in the financial services market?
- Rising interest rates (triggering higher interest for customers, which can increase payment defaults)
- High inflation around the world (reducing the purchasing power of the population, companies, and governments that might decide to spend and invest less)
- Changes in legislation and regulation (a change in regulations, such as regarding financial buffers for banks, for instance, can have a significant impact on the profitability and value of some companies)
- Cybercriminality
How can you invest in the financial services sector?
There are a variety of ways you can invest in the financial services market, depending on your trading style and strategy, your risk tolerance, your financial goals, your capital, and your time horizon. You’ll also have to take into account your knowledge of how finance, trading, and economics work and the type of market analysis you’ll use to spot the best opportunities (most technical analysis vs fundamental analysis).
If you’re risk-averse, you will mostly invest without leverage in big international companies over the long run. You can also invest in ETFs (Exchange-Traded Funds) that focus on the financial services sector or on a specific sub-category like insurance services, investment services, or banking services. It is also possible to focus on companies in a single geographic area or in different countries.
If you have a certain risk-tolerance and trading knowledge, you can use derivative financial products to focus on rapid price moves over the short-term, such as CFDs (Contracts For Difference), on shares from the financial services sector. As a more experienced investor and trader, you can also focus on options and futures contracts. With CFDs, you can profit from both rising and falling price movements and use margin trading and leverage, which help you to increase your exposure, diversify your positions, start relatively small, and give you a chance to make profit regardless of the direction of a stock. CFDs, options, and futures are also useful tools to hedge your long-term positions in companies.
The regulated CFD and Forex broker ActivTrades provides investors with the opportunity to invest in the financial services market through short-term trading using CFDs, but it also offers its users a chance to create a longer-term investments portfolio using a non-leveraged account without trading fees. If you want to find out more about share trading on ActivTrades, visit this page.
To decide if you should invest in the financial services sector now, you should also take into account the global macroeconomic landscape and its forecast, the economic cycle we’re currently in, and the trajectory of monetary policies, as they affect the financial markets, credit activity, as well as spending levels in the related economies. It’s also important to take into account individual factors linked to each sub-sector of financial services, as they all have their own advantages and limits.
In addition, it is crucial to choose the top-performing companies within the financial services industry by identifying well-positioned firms that can effectively leverage the trends driving the sector's long-term growth. These companies should also exhibit strong financial performance, with a healthy financial position and a high return on investment. Finally, ensure that the companies you select are dominant players with a competitive advantage and an excellent reputation.
Here are some examples of popular stocks from the financial services sector (all sub-categories):
- JPMorgan Chase & Co.
- Goldman Sachs Group Inc.
- Morgan Stanley
- Bank of America Corporation
- Wells Fargo & Company
- Citigroup Inc.
- HSBC Holdings
- BNP Paribas
- Barclays PLC
- UBS Group AG
- AXA SA
- Allianz SE
- Munich Re
- Prudential PLC
- American International Group
- ING Groep
- BlackRock Inc.
- Berkshire Hathaway Inc.
- Visa Inc.
- Mastercard Incorporated
- PayPal Holdings Inc.
- American Express Company
Remember to be cautious regarding how businesses in the financial sector make their money, meaning in which markets they're mostly involved in and what their risk assets level is. Avoid highly leveraged financial businesses, for instance. If you invest with a medium to long-term vision, focus on quality and high dividend-paying companies.
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