Rising Interest Rates Help Financials

 | Dec 09, 2013 | 4:00 PM EST  | Comments
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A variety of stronger-than-expected economic reports hit the market last week. Third         quarter GDP was revised up to a robust 3.6%, albeit almost half of the increase was due to inventory builds. The November Jobs Report also printed more than 200,000 jobs, better than consensus.

Consumer confidence also hit a five-month high. October consumer credit and new home sales jumped more than expected. Finally, November PMI posted its strongest reading of the year.

These reports point to an accelerating economy. Their strength also has spurred additional commentary around the Federal Reserve "tapering" in the near future. If the strength of the economy continues to pick up steam, interest rates are almost certain to rise further in 2014.

Investors should get in front of this development by increasing their allocation to financials. Both banks and insurance companies should be beneficiaries of rising interest rates. Banks will see their net interest margins expand and insurance investment portfolios should benefit from higher yields.

Here are two large-cap financial plays that should welcome higher interest rates in 2014.

Metlife (MET) is the type of large diversified insurance provider that should continue to be buoyed by rising interest rates. This was noted by Deutsche Bank a few weeks ago when it lifted its price target on the shares to $59 a share.

Metlife's valuation is solid. Ever after a stellar performance so far in 2013, the stock still goes for under book value and approximately 9x this year's earnings. I also like the fact the company recent divested itself of its banking assets. Hopefully, this keeps it from being designated a "too big to fail" institution by the Feds, which would remove an overhang over the stock.

The company is growing its global footprint by moving into some faster-growing emerging markets. These efforts are starting to bear fruit. Revenues from South America were up 14% Y/Y in the most recently-reported quarter. The stock yields just over two percent. However, the company should get permission from the Fed over the next year to lift its dividend payout and to accelerate stock repurchases.

I pulled the trigger last week and added Citigroup (C) to my portfolio. The bank has made some good progress over the past year now that it has a real banker in charge. This is another large financial that still sells for less than book value. Stock is also a solid value at just 9.5x forward earnings.

Citi also has the most exposure to global growth of any of the major U.S. banks. Of the company's revenues, more than 50% is generated overseas. Earnings are tracking to better than a 20% gain this year and the bank should be able to post a 15% increase in FY2014.

The bank pays a minuscule dividend currently. That should change once Citi gets regulatory approval to pay a more normalized dividend payout as well as to lift its stock repurchase authorization. I expect both to happen sometime in 2014.

Neither of these two large-capitalization financial selections would be what I would call "sexy" picks. However, I don't believe the market will provide anywhere close to the returns investors received in 2013. Interest rates should continue to rise in 2014 as well. In that sort of environment both of these financial stocks should outperform the overall market.

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