Kevin Warsh takes the reins as Federal Reserve chairman starting in May – assuming all goes well in his Senate confirmation hearing.
Fed policy has had a major outsized impact on stock returns for the past 25 years, but particularly since 2020. It was the Fed’s massive monetary stimulus that inflated the pandemic-era “FOMO” bubble… and the nasty inflation that came with it.
Of course, it was the Fed’s decision to abruptly cut off the stimulus in 2022 – and go on the most aggressive rate-hiking spree in history – that caused the prices of stocks, bonds, gold and virtually every other tradable asset to drop that year.
Asset prices exploded higher again in 2024 and 2025 due in no small part to expectations of sharply lower rates… And returns have been tepid so far in 2026 as those expectations have come down.
Suffice it to say, Jerome Powell’s term as chairman has been a wild ride.
So, what kind of Fed chairman will Warsh be?
That remains to be seen, of course. Warsh previously had a reputation as a “hawk” who favored higher interest rates and sharply criticized his predecessors for their experiments with “quantitative easing” – meaning printing new dollars to buy longer-term bonds in an attempt to force long-term rates lower.
Yet, perhaps in an attempt to get President Donald Trump’s attention, Warsh has talked a good game over the past several months about pushing short-term rates lower, suggesting that a boom in productivity due to AI would keep inflation in check.
So… how do we unpack all of that?
Taken at face value, Warsh’s comments suggest he’s in favor of lower short-term rates but comparatively higher long-term rates, or a steeper yield curve.
There are a lot of moving parts here, but a steeper yield curve – a world in which longer-term yields are higher than shorter-term yields – is good for banks and for financial firms in general because they often borrow at short-term rates and lend at long-term rates.
Given the outsized importance of the role the Fed plays in this corner of the economy, let’s do a financial sector X-ray.
A Peek Under the Hood
One thing is certain. Whether the new Fed chairman ends up being dovish or hawkish, the financial sector as a whole is a minefield.
A majority of the stocks in the sector – 55 out of 103 – rate as “Bearish” on my Green Zone Power Ratings system, and another 26 rate as “Neutral.”
Only 22 rate as “Bullish,” with a Green Zone Power Rating of 60 or higher.
The Fed may have huge sway over the stock market as a whole and for financials in particular. But the Fed isn’t everything. The health of the economy matters too, as do the specific business conditions of each individual company.
So, let’s do a deeper dive into the system to see what’s driving the Green Zone ratings of financials.
Where Do Financials Pick Up Points?
This may come as something of a surprise given that financials are often lumped in with stodgy “old economy” companies, but 75 out of 103 stocks in this space rate as “Bullish” on my growth factor with a factor rating of 60 or higher.
A majority, at 55, also rate as “Bullish” on my quality factor.
However, the “Bullish” factor ratings start to trail off a little. Only 40 stocks rate as “Bullish” on value. Plus, 27 and 25 stocks rate as “Bullish” on volatility and momentum, respectively.
The relatively few financial stocks rated as “Bullish” on momentum is interesting. It implies that investors aren’t particularly enthusiastic about the road ahead. Some of this may be skepticism about Warsh… and some may simply be concern from investors about market uncertainty and rising default risk.
So, how do we navigate this turbulence?
By focusing on the best, of course. I made a list of the top 10 highest-rated financial stocks. Let’s give it a look…
Only the Best
One thing is immediately obvious. The highest-rated financial stocks aren’t banks. Of the top 10, only one – the Bank of New York Mellon (BK) – is a bank.
With the exceptions of Mellon and Cboe Global Markets (CBOE), the commodities exchange, every other stock on the list is an insurance company.
That’s not entirely surprising. Insurance was long the favorite industry of Warren Buffett, the Oracle of Omaha himself. Over the course of a few decades, he converted Berkshire Hathaway (BRK-B) from a failing textile mill into one of the world’s premier insurance companies.
And what makes insurance such a fantastic business?
It comes down to “float.”
Float is the pool of premium dollars collected upfront before claims are paid out. Depending on how good the company was at underwriting risk, the claims may never get paid out and the float can grow and compound indefinitely. As Buffett figured out early, this provides insurers with large sums of capital to invest for years – or very possibly forever – at virtually no cost. The investment returns earned on the float are essentially free money, creating powerful compounding for shareholders over time.
Insurance companies will have their ups and downs, of course. A bad storm season, unrest, or a wild fire can erase years’ worth of profits. But if the model was attractive enough to get Buffett’s attention, we should take that under advisement!
To good profits,
Adam O’Dell
Editor, What My System Says Today
