It’s Earnings Season — starting with financial stocks. Investor funds are flowing into financial stocks at a record pace ahead of Friday earnings from JPMorgan (NYSE:JPM), Wells Fargo (NYSE:WFC) and Citigroup (NYSE:C). Financials are off to its best start in over a decade.

2022: The year of rising interest rates

Loans are one of the bank’s largest earning sources — and profitability depends on interest rate levels (the higher the better). With rates expected to rise this year — banks couldn’t be more excited.

• Yesterday, reports showed inflation hit 7% in December — and the remedy to high inflation? Higher interest rates…
• The Fed is hinting at aggressive rate raises in 2022 — with Fed officials expecting at least three — the first due as early as March.

After years of falling interest rates, we might be in for a long cycle of climbing rates ahead. But this will only matter if businesses and consumers are willing to borrow — and loan growth has been slow in the past year.

Positive vibes: Commercial and industrial loan growth grew 1.9% in 2021’s last quarter, up from the previous quarter — a positive sign for banks.

The financial trade is on

Analysts have a positive view on banks — with Edmund Shing of BNP Paribas (via Bloomberg) seeing earnings going up, balance sheets remaining strong and dividend/share buybacks increasing.

This led to investors crowding into bank stocks ahead of earnings…

• Over a third of all money placed in US ETFs in 2021 went into finance-related ETFs (via Bloomberg).
• Funding into the Financial Select Sector SPDR Fund (NYSE:XLF) grew at the fastest pace in a year — up 4.6% in 2022 while the broad S&P 500 is down 1.3%.

But investors shouldn’t take earnings reports as a sign stocks will move up. In each of its past five earnings reports, JPMorgan’s stock fell on the day of reporting (per Reuters) — with similar results from other banks.

Investors: Beware the top

In the last rate increase cycle (2016), the majority of the bank sector’s outperformance came in the first few months (via Morningstar). Afterwards, banks began underperforming the S&P 500.

Investors anticipate strong earnings — which may already be priced in. While the economic situation is likely to keep benefiting, investors should closely watch their positions without overstaying their welcome.