The financial services sector comprises businesses such as large banks, credit services companies, asset management companies, brokerage houses and mortgage lenders. Some of the largest and most profitable companies in the world are in the financial services sector; as a result, many growth-conscious investors see it as an attractive place to put their money. While this sector offers the potential for fabulous returns, it is also fraught with risk for investors who do not possess a keen understanding of what drives share prices. While many factors can compel share prices in the financial services sector to move one way or the other, the three biggest are general economic conditions, interest rates and regulatory changes.
General economic conditions, which encompass such factors as unemployment, median household income and growth (or contraction) in gross domestic product (GDP), are perhaps the biggest catalyst for stock price increases or decreases in the financial services sector. Brokerage houses, mortgage companies and credit card companies are but a few financial service businesses that perform much better in a good economy. When the economy is strong, people have more money to invest with their brokers, they purchase more real estate – often financed by mortgage loans – and they shop more. Sharp economic contraction spells disaster in the financial services industry; people have less money to invest and spend, and they have more difficulty obtaining credit. The Great Recession of 2007-2009 witnessed the dissolution of countless financial firms, from industry giants such as Lehman Brothers to hundreds of smaller mortgage companies and investment houses.
Interest rates have a major influence on share prices in the financial services industry. Low interest rates encourage consumers to borrow and provide less of an incentive to save, while high interest rates have the opposite effect. The majority of financial institutions make their money by lending it out and charging interest. Conversely, when customers decide to save their money, the institution is the one that has to pay interest. As a general rule, financial services companies are more profitable and have higher stock prices when interest rates are low. Interest rates are mostly controlled by supply and demand. However, the government has influence as well. When it wants lower interest rates, possibly to stimulate the economy, it buys securities from banks, giving them more money to lend and driving down interest. When it wants higher interest rates, such as to tamp down inflation, it purchases securities, which decreases the monetary supply and raises borrowing costs.
Investors cannot ignore the effects of government regulation on financial services stock prices. The market perceives regulations as suffocating to a business's ability to make money, so stock prices tend to fall when a restrictive piece of legislation targeting a certain industry is enacted. In the wake of the financial crisis of 2008, many governments around the world developed a sharp focus on regulating banks and financial institutions. Shrewd investors keep a watchful eye over developments in that arena.