A funny thing happened to financial stocks in 2004: The Federal Reserve boosted interest rates, but stocks didn't plummet. In fact, the financial sector had a pretty good year even as the Fed raised its target for short-term interest rates from 1% to 2.25%. There's a lesson for investors here: The spread between the interest rates banks pay for capital and the interest rates they charge to lend capital matters more than the absolute level or direction of interest rates. That explains the gains financial stocks posted and convinces me that Bank of America ( BAC), U.S. Bancorp ( USB), Main Street Banks ( MSBK), Capital One Financial ( COF) and MBNA ( KRB) will deliver above-market returns for 2005. I'll return to the future of those five stocks in a moment, but first let's take a closer look at how some big financials did last year.
Pockets of Outperformance
At first glance, the year was solid but not spectacular for investor favorites in the sector. Citigroup ( C) was up 3%, Washington Mutual ( WM) rose 10% and Bank of America gained 18%. But there were pockets of huge outperformance: Credit card companies Capital One Financial and MBNA returned 44% and 37%, respectively; regional banks Main Street Banks and Commerce Bancorp ( CBH) returned 34% and 24%, respectively; and perhaps most surprisingly, some thrifts that depend on mortgage lending soared, including Golden West Financial ( GDW), which returned 44% for the year.