The breakout to record highs by bank stocks, plus their strong earnings and favorable valuations, suggest more good times ahead for the financial sector

The breakout to record highs by bank stocks, plus their strong earnings and favorable valuations, suggest more good times ahead for the financial sector.

The financial sector has been on fire of late, as strong earnings, fading concerns about private credit and improving capital-markets activity have provided a beacon for investors looking to rotate away from previous highfliers that have fallen upon hard times, like chip stocks and artificial-intelligence hyperscalers.

If graded on a curve for performance this year, financial stocks would still barely receive a passing grade. But a look at several charts, and actual earnings numbers, shows why the stocks have performed so well the past couple months - and provide a strong case for them to keep outperforming in the coming months.

The State Street Financial Select Sector SPDR ETF XLF has gained 4% in 2026 through Friday, which ranks eighth among the SPDR ETFs tracking the S&P 500 index's SPX 11 sectors. (The S&P 500 itself has rallied 9.4% this year.) But XLF's gain includes a 6.2% rally in July, which was its best monthly performance since it rose 6.5% in January 2025, while it reached a record closing high on July 28.

"I think the move higher that we've seen this month is well justified," said Brock Weimer, an investment-strategy analyst at Edward Jones. Not only were earnings reports "pretty strong across the board," but concerns about private credit and the threat posed by AI have also faded, he noted.

Those fundamentals are positive, but the "strength and upward momentum" shown by the XLF and bank subsector charts, not to mention valuations, is why financials are one of the sectors Piper Sandler chief market technician Craig Johnson favors, while the chip stocks are undergoing a technical reset.

For valuation, in the form of forward price-to-earnings expectations, financials are the ninth-cheapest of the 11 sectors, according to FactSet data. And in terms of earnings, financials have seen the largest year-over-year increase in revenue in July, according to John Butters, senior earnings analyst at FactSet.

Despite the recent rally to a record high, the financial sector's fundamentals still aren't being fully reflected in the stocks, according to Michael Arone, chief investment strategist at State Street Investment Management. He said the sector still trades at a discount of more than 30% to the broader market.

Financials break out

Financials had been under the gun for most of the past year, and when compared with the S&P 500, they had reached a historic low in early June.

But all that changed with July's rally.

The following chart shows how the financial sector, when compared with the performance of the S&P 500, has broken out of a 15-month downtrend line, to suggest a new trend of outperformance is starting.

Financials broke out from a long-term downtrend relative to the S&P 500, to suggest a new trend of outperformance may have just begun.

And looking at the bank subsector, the recent rally has eased fears that the sector's previous underperformance may have been a precursor to something more nefarious for the broader stock market, given how important the sector is in helping to fuel economic growth.

Any worries of recent bank underperformance being the canary that warns of a market selloff have been soothed by a breakout by the bank subsector.

The State Street SPDR S&P Bank ETF KBE has rallied 9.7% over the past two months, reaching a record high earlier this month.

If that's not enough, the XLF fund has also broken out from a long downtrend when measured against the PHLX Semiconductor Index SOX, suggesting the rotation out of previous highfliers and into value sectors like financials looks set to continue.

The reign of the chip sector may have just ended.

AI and July jobs report

The economic calendar kicks off Monday with a reading on the manufacturing sector, which is expected to show expansion for a seventh consecutive month. That's been one of the recent bright spots of the economy, as the building of data centers to support the growth in AI has helped offset any drag caused by tariffs.

But the highlight of the week comes on Friday with the government's July jobs data. Job growth may not be great - but as Fed Chair Kevin Warsh said last week, "job gains have kept pace with the workforce, and the unemployment rate has changed little."

Space, chips, burgers

While the flow of earnings reports slows from last week, there are still some big names reporting that could impact the market.

Earnings from Advanced Micro Devices $(AMD)$ after Tuesday's closing bell could provide investors some guidance on the outlook for chip stocks, which just suffered a 20% plunge in July - their worst monthly performance since October 2008.

Also on Tuesday, there's the first earnings report from Elon Musk's SpaceX $(SPCX)$, which after a strong start to its public life in mid-June has seen its bonds pummeled and its stock sink well below its initial-public-offering price.

For a reading on consumers, McDonald's $(MCD)$ also reports on Tuesday. There's been a notion that stubborn inflation, including a big jump in oil (CL00) (BRN00) and gasoline prices since the start of the Iran war, has slowed discretionary spending. That helped send McDonald's stock to a two-year closing low in mid-July.

-Frances Yue