NEW YORK ( TheStreet) -- A continued housing recovery and increased dividend and share buybacks are likely to lift financial stocks in 2013, according to Keefe, Bruyette & Woods.

KBW's analysts nonetheless expect moderate economic growth and expect a "another transitional year for financial companies."

"The U.S. economy is still bridging the gap between the last recession and robust economic expansion. In this environment, financial companies will need to contend with low interest rates, moderate economic growth, and increased competition," the KBW report states, adding that "the best opportunities for financial stock investing in 2013 will be diversified financials, including mortgage finance and payment processing where growth opportunities exist; life insurance companies and select universal banks where valuations are compelling and expense reductions can take hold."

KBW's analysts also expect M&A activity to increase next year, so they recommend regional banks and property and casualty insurance companies that they believe are consolidation targets.

The 2013 outlook, published by top strategist and head of research Fred Cannon, offers no specific company recommendations. However, a separate report, updating KBW's "model portfolio," shows U.S. Bancorp ( USB - Get Report) as the stock which has the highest weighting relative to its weighting in the Standard and Poor's 1500 Financials index, followed by M&T Bank Corp ( MTB - Get Report), Citigroup ( C - Get Report), SunTrust Banks ( STI - Get Report)and ProAssurance Corp. ( PRA - Get Report).

KBW's analysts are scheduled to offer more detail on their top picks for 2013 next week.

-- Written by Dan Freed in New York.

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