Why the banking sector is better, but with room for improvement

Russ explains the good news behind his upgrade of the global financial sector as well as the bad news keeping his sector outlook somewhat subdued.

Five years after the 2008 financial crisis, the US financial system – the proximate cause of the crisis –is in much better shape. Leverage levels are considerably lower and a regulatory overhaul has left US financial institutions better capitalized and less risky. In addition, a rising-rate environment has historically helped boost banking sector profitability.

Market Realist – The graph above shows you the national financial conditions leverage subindex over the years. The index takes an average value of 0 and a standard deviation of 1, dating back to 1973. Positive values mean leverage conditions are tighter than average. Negative values show looser conditions.

As you can see from the graph, the leverage subindex peaked in 2007–2008. This showed an excess leverage buildup that has fallen considerably thereafter, indicating deleveraging in the financial system (XLF)(KRE).

As leverage has decreased and banks have shored up capital, investor confidence too has come back in the sector.

According to Bloomberg, financial stocks (XLF) rose by a record 33% in 2013. This is the highest ever since 1997. The financial sector outperformed broad market indices like the S&P 500 at 29.6% (IVV)(SPY) and the Dow Jones Industrial Average at 26.5% (DIA) in 2013.

Read on to the next part of this series to see how the banking sector has become more stable.