3 Financial Stocks to Watch as Interest Rate Cuts Approach

Key Points

• Three stocks in the financial sector stand out to investors as potential risers in the coming quarters.
• Launching from the potential interest rate cuts coming from the Fed, these companies have more upside ahead.
• Wall Street analysts and institutional buyers seem to be on the same page about what could be ahead for these stocks.

The stock market has now priced in the interest rate cut narrative. Investors can point to this idea by watching how the S&P 500 has gone from an uptrend market to a channeling—or even bracketing—market around a support and resistance area. The good news is that there are other stocks that haven’t yet topped or even caught up to pricing in these rate cuts.

Even if price action in these stocks starts to slow down, investors need to know that this is only a natural extension of the broader S&P 500, and what comes next is going to be the reflection of the next 6-9 months, where the actual effects of interest rate cuts have not yet been reflected in the financial sector. Noticing that the Financial Select Sector SPDR Fund NYSEARCA: XLF now trades at 98% of its 52-week high, compared to 95% in the S&P 500, can be the beginning of a bigger move.

As the market becomes more bullish on financial stocks, three stand out for investors to watch out for before, during, and after the Federal Reserve cuts interest rates. These stocks include American Express NYSE: AXP to diversify and stay away from most risks in the consumer discretionary sector, then Capital One Financial Co. NYSE: COF to focus on the consumer benefits and higher potential upside, with a higher reward (and risk) opportunity in small business lender Upstart Holdings Co. NASDAQ: UPST.

Wall Street Isn't Alone in Its Bullish Outlook on American Express Stock

American Express stock trades at 96% of its 52-week high, the first bullish sign for investors to consider. The reason behind this price action is due to the business model itself, which provides credit services for the select few clients who can meet the company’s selective process.

Through strong credit profiles and financial situations, American Express customers help the company diversify lending risks, especially during economic uncertainty. Understanding these strengths could be one reason why some institutional investors have been looking to buy more of this stock recently.

Those at Legal & General Group bought 0.2% more of American Express stock, bringing their net position to $1.2 billion today. Following this buying came the Bank of Montreal, boosting their holdings by 0.7% to net a position of $251.6 million.

More than that, analysts at Bank of America have landed on a price target of up to $263 for American Express stock, calling for a 5.4% additional upside, which would be a new 52-week high. As interest rates come down, American Express could have a new wave of demand for its services while cutting out most of the risk.

Capital One Financial Could Deliver the Double-Digit Upside Predicted by Wall Street

On the other end of the spectrum, investors can look at Capital One Financial stock, which offers services to a more common consumer credit base. While this may be a little riskier, especially as credit card delinquency rates are on the rise today, the reward is also bigger.

Wall Street analysts now forecast up to 21.5% earnings per share (EPS) growth for this company in the next 12 months, leaving those at Jefferies Financial to land on a price target of $165 for Capital One Financial stock today. To prove this valuation right, the company must rally by as much as 16.6% from where it trades today.

Considering that Capital One Financial stock’s short interest has been on a decline since the first quarter of 2024, investors can take this as another bullish sign: bears capitulating in front of all the potential upside inherent in the stock for the following quarters.

Willing to support this view, Clearbridge Investments decided to boost their stakes in Capital One Financial by 5.5% as of August 2024, bringing their net investment up to $507.2 million today. As up to $4 billion in institutional capital made its way into Capital One stock over the past 12 months, investors can lean on the market’s confidence.

Small Caps Are Set to Rally Again, a Bullish Sign for Upstart Stock

Fundstrat's Tom Lee has been bullish on small-cap stocks coming into the end of the year. He bases his thesis on the fact that lower interest rates are one of the best drivers for this niche in the market. As smaller companies rely heavily on available and flexible financing, Upstart stock can ride a double tailwind.

Operating in the lending space for both consumers and businesses, Upstart could deliver a serious upside as both consumer segments could be set to bring additional demand and financial momentum into the company. Now that the company trades at 72% of its 52-week high, there is one inflection point for investors to consider.

Wall Street analysts forecast a downside of 23.5% from today's stock price, which could be attached to the recent bearish price action seen in the stock, which is something to consider. On the other hand, the stock trades at a price-to-book (P/B) ratio of 5.2x, which is significantly above the rest of the credit institutions industry's average valuation of 2.2x.

As markets typically have a good reason to pay a premium for a stock, it could offset some of the company's other negatives, but investors should still be wary of the risks. This list covers the low risk in American Express, medium risk in Capital One Financial, and high risk in Upstart so that a proper portfolio could be built around these trends.