Concerns over the Chinese economic slowdown, volatility in commodity prices and the low interest rate environment kept the financial sector under pressure in the beginning of the year. The Brexit referendum further added to the concerns.

However, the picture looks much brighter at the year end, driven by stabilizing oil prices, the recent Fed rate hike and heightened expectations of a favorable operating environment under President-elect Donald Trump. Notably, year to date, KBW Nasdaq Bank Index gained 27.7%.

Shares of The Goldman Sachs Group, Inc. (GS Quick QuoteGS - Free Report) and Morgan Stanley (MS Quick QuoteMS - Free Report) have been roaring since the election date. Putting up a great show, over the past three months, Goldman and Morgan Stanley gained 46% and 37.2%, respectively, outperforming the 27.5% growth recorded by the Zacks categorized Finance industry.

Goldman is currently trading at $243.09 (as of Dec 20, 2016), almost near its all-time high, while Morgan Stanley is trading at $43.50. Both the stocks currently sport a Zacks Rank #1 (Strong Buy).

You can see the complete list of today’s Zacks #1 Rank stocks here.

Why the Rally Should Continue?

Solid Growth in Trading Revenue: Brexit-driven volatility spurred trading revenues for banks including Goldman and Morgan Stanley during the third-quarter 2016. Notably, Morgan Stanley recorded 61% rise in its fixed income, currency and commodities trading revenues, while Goldman experienced 34% rise in net revenues from fixed income, currency and commodities client execution during the third quarter.

On a similar note, Trump’s victory is set to give another boost to these two trading powerhouses. Investors’ concern over uncertainties following the election has been driving increased trading activity leading to heightened volatility.

Less Regulation to Ease Revenue Pressure: Revenues of Goldman and Morgan Stanley – the two former independent investment banks that became bank holding companies to ride out the 2008 crisis – have been under pressure amid a stringent regulatory landscape. The regulations not only require the banks to maintain higher capital against risky assets, bear increasing compliance costs, but also limit their flexibility in doing operations in several areas.

However, under Trump’s regime, a repeal or considerable change in Dodd-Frank Act, which was adopted in the wake of the 2007–09 crisis, might drive bottom line of the banks to some extent.

Notably, Trump’s transition website portrays Dodd-Frank as “a sprawling and complex piece of legislation that has unleashed hundreds of new rules and several new bureaucratic agencies.” It also says, “The Financial Services Policy Implementation team will be working to dismantle the Dodd-Frank Act and replace it with new policies to encourage economic growth and job creation.”

Lower Taxes to Trigger M&A Activities: Potential lower corporate taxes under Trump administration should benefit earnings of Goldman and Morgan Stanley. Further, being leading global advisers in M&A, the companies stand to benefit from increased M&A activity.

Gain from Fed Rate Hike: Earlier this month, the Federal Open Market Committee raised the target range for the federal funds rate by 25 basis points to 0.50–0.75% from 0.25–0.50%. Further, signaling confidence in the U.S. economy, the Fed expects three rate hikes in 2017 instead of the previous forecast of two. Notably, Goldman and Morgan Stanley are not lending giants.

Hence, the rate hike will not be a significant gain for the two firms, unlike other average U.S. banks. However, the rising rate environment, to some extent will contribute to the earnings of the two companies, which have been growing their loans and deposits balances over the past several years.  

Business Strategies to Suit the Changing Market Dynamics: Following the crisis, investment banks like Goldman and Morgan Stanley are pressed to operate more like universal banks and rely more on consumer deposits to fund their activities rather than depending on short-term debt and deposits from financial clients. The two companies are sketching strategies in their own ways.

Goldman, which is widely focused on large companies and wealthy clients, is now targeting consumers and small businesses. Notably, Goldman, in its effort to boost the GS Bank’s business, acquired the online deposit platform of GE Capital Bank in Apr 2016. It also launched a digital consumer lending platform, Marcus by Goldman Sachs. On the other hand, Morgan Stanley remains focused on strengthening its solid Wealth Management business.

Upward Estimate Revisions: For Goldman, over the last 60 days, the Zacks Consensus Estimate for the current year increased 4.2% to $15.7 and advanced nearly 3% to $18.35 for 2017. The company has long-term expected earnings per share (EPS) growth rate of 11.6%.

Also, the Zacks Consensus Estimate for Morgan Stanley moved up 3.4% to $2.73 for 2016 and 6.3% to $3.21 for 2017, over the last 60 days. Currently, the company has a long-term expected EPS growth rate of 10.4%.

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