Financial Stocks Are Trying to Break Out. It’s Only a Matter of Time.

JPMorgan Chase, long a Wall Street darling, reported higher earnings than expected for both the first and second quarters. (Gabby Jones/Bloomberg)

Financial stocks are poised to break above a critical level even though their failure to do so thus far has raised concerns. The sector’s fundamentals show it will happen soon enough.

The Financial Select Sector SPDR exchange-trade fund, home to banks, asset managers, insurance companies, and other diversified financial companies, has gained 9% this year, beating the S&P 500 ’s 7% gain.

One reason is that analysts’ forecasts for earnings have been rising since the start of the year, partly because of optimism about JPMorgan Chase , a longstanding Wall Street darling that accounts for 12% of the sector’s aggregate profits. The consensus call for its earnings has jumped 16% since the start of the year as profits for both the first and second quarters came in higher than expected.

The short-term issue is that gains in financials have stalled. The exchange-traded fund sits at just over $52, below its record of just over $53. Sellers have come in to knock the price lower every time it has neared that level since late last year. Even better-than-expected financial results from most of the large investment banks, disclosed last week, led to only small gains, keeping the ETF from breaking new ground.

That caused concern that these stocks may have already factored in as much earnings growth as they are likely to achieve for the near term, making shares vulnerable to a decline. The stocks could certainly fall in the near term, especially if tariff rates go up Aug. 1, raising fear of an economic slowdown that would hurt many sectors.

A closer look, though, illustrates that the shares could easily headed higher. The ETF has been rising, albeit with some volatility, since late 2022, when it traded at $31. It has risen 67% since late 2023. Even when it dips slightly, pausing from the rally, it doesn’t break below what technical analysts call its trend line upward.

That is why, as long as earnings continue to grow, the fund will eventually break above $53 and continue along its merry way. Given the group’s fundamentals, “we remain excited about the ability for investors to identify winners in the financials sector,” writes Trivariate Research strategist Adam Parker, who recommends an Overweight allocation to the sector. “Medium-to-long-term strength is likely.”

As Parker noted, financial companies are poised to perform well. Earnings from the investment banks were strong last week.

JPMorgan, for example, posted a largely solid second quarter. Total revenue of $44.9 billion fell versus last year’s $50 billion, but that is because in last year’s second quarter the bank saw a one-time jump from a sale of Visa shares, which the bank counts as revenue. That left the total $7.7 billion lower this year.

Excluding that, total revenue would have been up about 6% year over year, driven by increases in loans, investment banking transactions, and trading activity, all of which is consistent with moderately growing consumer and business demand, and rising markets.

The kicker was that the bank’s provision for credit losses, cash set aside to cover potential unpaid loans, dropped 7% to a total of $2.85 billion. That helped lift the bank’s pretax profit margin, sending earnings upward. Per-share earnings rose 12% from a year earlier, partly because the bank repurchased $7 billion of its stock in the quarter.

Numbers like that underpin analysts’ optimism. For all banks, analysts are looking for 7.2% annual revenue growth this year and next, and 15% EPS growth annually through 2026, according to FactSet. The assumption is that as long as the tariff picture doesn’t significantly worsen, inflation will remain close enough to the Federal Reserve’s 2% goal that it could cut interest rates and extend the economic growth banks have enjoyed.

Increasing bank profits would go a long way in bringing total earnings for the financial sector higher. The net income expected this year for JPMorgan, Goldman Sachs, Morgan Stanley, Citigroup , and Bank of America accounts for more than a quarter of aggregate earnings in the financial sector, according to Barron’s calculations using FactSet data.

Asset-management companies are in position to help as well. Fees for managing money, generally a percentage of the funds overseen, tend to rise when stock prices increase, so those stocks often rally along with the broader market. The S&P 500’s gains over the past few years have lifted their earnings—a critical factor for the financials ETF because BlackRock , Charles Schwab, Invesco, State Street, Blackstone, Carlyle Group, Apollo Global Management, and TPG account for about 10% of the sector’s profits.

The point is that financial stocks will break out soon. Investors may prefer not to buy new shares at this price, but they should buy on dips. Anyone who has held the stocks for a long time should hold on to them.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com