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Are Financial Stocks Safe to Buy Again

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During the global financial crisis of 2008, bank stocks were hit the hardest.

From the collapse of investment bank Lehman Brothers to the government bailout of insurer AIG to the fire sale of commercial bank Washington Mutual, investors learned the hard way that even well-established financial stocks could ruin your portfolio.

What's more, several big banks are actually paying bigger dividends since before the financial crisis, despite stricter regulations and oversight. Take JPMorgan Chase & Co., which recently announced plans to increase its dividend to 56 cents a share – up 47 percent from just 38 cents a share in 2008.

With that combination of strong share performance and juicy dividends, some experts are saying the financial sector is once more a reliable source of income for investors.

Take hedge fund billionaire Daniel Loeb, whose Third Point Management just took a big position in asset management firm BlackRock. Or consider investing icon Warren Buffet, who continues to favor banks heavily, with his firm Berkshire Hathaway recently acquiring enough shares to become the largest shareholder in both Bank of America and Wells Fargo & Co.

But will this performance continue, or is the best already behind us for bank stocks?

Big factors lifting bank stocks. The reasons behind the recent rally across a wide swath of financial stocks are numerous but pretty simple to understand.

In short, it's a combination of three things: regulatory reform, higher interest rates and overall economic growth.

The obvious catalyst for bank stocks in late 2016 was the election that ushered in President Donald Trump and a firm Republican majority in Congress. The intervening months have seen several executive orders favorable to certain businesses, and overtures at legislation to reform financial regulations including Dodd-Frank.

But there is a longer-term trend that is equally powerful, says Matthew Bartolini, head of SPDR Americas Research at State Street Global Advisors – namely, the continued march higher for interest rates.

The key Federal Reserve funds interest rate has risen from a low of range of around 0.1 percent in late 2015 to a rate approaching 1.2 percent after the most recent interest rate increase in June.

"The Fed has raised rates over the last 20 months, and while we haven't seen a return to pre-crisis eras, we have seen an uptick in net interest margins," Bartolini says, and that in turn has delivered bigger profits for bank stocks.

Banks have grown since 2009, but have also become more stable. Some investors may still be wondering if banks are a safe bet in 2017. After all, the metrics at major financial stocks were looking just fine before the bottom fell out. And if Republicans are rolling back regulations, there is a risk some companies make the same mistakes they did almost a decade ago.

However, it's important to remember that most safeguards created during the financial crisis remain in place – most notably, the demands that banks keep a larger capital cushion to absorb any mistakes they make.

In fact, 2017 is the first year since the financial crisis that all 34 major banks undergoing "stress tests" by the Fed were granted a passing grade under these stricter capital requirements.

This shows the banks are healthy, Bartolini says, but also could signal that the sector has a lot of tools at its disposal to deliver bigger profits to shareholders going forward.

After all, one element of the Fed's stress tests involves banks asking regulators for approval on any dividend and buyback plans. And better test results should mean banks get the OK to return more of their capital back to investors.