Big Banks set to end 2025 at record highs, the top investment themes for 2026

Key Concepts

• KBW Banking Index: A benchmark tracking the performance of US banks.
• Yield Curve Inversion/Uninversion: A phenomenon where short-term interest rates are higher (inversion) or lower (uninversion) than long-term rates, impacting bank profitability.
• Net Interest Income (NII): The difference between the revenue a bank earns from its lending and investing activities and the expenses it pays out to depositors.
• M&A (Mergers & Acquisitions): The consolidation of companies through mergers or acquisitions.
• FDA Approval Levels (Level 2 & 3): Stages in the US Food and Drug Administration’s drug approval process, with Level 3 indicating near-final approval.
• Small Modular Reactors (SMRs): Smaller, more flexible nuclear reactors gaining attention as a potential power source for data centers.
• Catalyst Event: A specific event (e.g., drug trial results) that can significantly impact a company’s stock price.
• Forward P/E Ratio: A valuation metric comparing a company’s stock price to its expected future earnings.

Market Overview & Banking Sector Performance

The week is concluding with modest gains in stock futures. NASDAQ futures are up approximately 0.2%, while the Dow and S&P 500 show minimal change. This follows the release of delayed economic reports and notable earnings releases, including Micron. The last full trading week of the year is drawing to a close, with holiday-shortened weeks ahead.

Surprisingly, the best-performing sector of 2025 has been America’s biggest banks, not AI or tech. The KBW Banking Index is up roughly 28% year-to-date, outperforming the S&P 500, a trend analysts predict could continue into 2026. This performance is attributed to several factors: growth plans within the banks, deregulation under the Trump administration, and strong performance in Wall Street operations, specifically trading and deal-making.

Banking Sector Dynamics & Future Outlook

David Hollerith, a banking reporter, highlighted the unique combination of factors driving bank performance. A key positive development has been the uninversion of the yield curve. Banks benefit when the rate at which they lend is higher than the rate at which they borrow. The uninversion, coupled with repricing of securities portfolios, is contributing to positive results. However, banks are also preparing for a potentially lower rate environment and seeking alternative growth avenues, such as increased lending.

Consolidation within the banking sector is also a significant trend, with regional bank mergers already occurring in 2025. Kevin Mon’s, CIO, noted that financial mergers tend to be more successful than media mergers, citing the potential for efficiency gains and synergies. He believes smaller-cap regional banks offer more growth opportunities than large money center banks, particularly those diversifying into wealth management, insurance, and fintech.

Quote: “I’m optimistic on the outlook for the financial sector in 2026, but I see more growth opportunities for the smaller cap regional banks than I do for the large money center banks.” – Kevin Mon’s

IPO Market & AI Impact on Financials

The IPO market is expected to strengthen in 2026, potentially boosting capital markets activity for banks. Large potential IPOs, such as SpaceX and Fannie Mae, are being closely watched. The current bull market, entering its fourth year, could be further fueled by increased IPOs, share buybacks, and M&A activity.

AI is rapidly transforming the financial sector. Banks are investing heavily in AI to improve efficiency, particularly in areas like customer service (reducing call center staff) and deal-making. Bank of America has already reduced its call center staff by thousands due to AI implementation. AI is also being used to analyze loan portfolios and identify risks and opportunities.

Quote: “The biggest risk in the AI revolution is those companies who underspend or don't spend at all as opposed to those who potentially overspend.” – Kevin Mon’s

While AI may lead to job displacement in some areas (e.g., junior analysts), it also enables banks to launch new products and scale their businesses. Banks are focusing on training existing employees to leverage AI tools and enhance their analytical capabilities.

Investment Strategies & Trending Tickers

Kevin Mon’s outlined several investment themes for 2026:

• AI Infrastructure: Investing in companies supporting the buildout of AI infrastructure, including data center construction (ACOM, MCOR), electrical connectivity, cooling solutions (Comfort Systems - FIX, up over 100% YTD), and power solutions.
• Power Solutions: Recognizing the critical role of power in supporting AI development, focusing on utility companies like Duke Energy (DUK), particularly those with nuclear power capabilities.
• Defense & Security: Capitalizing on increased global defense spending, investing in companies like L3 Harris and smaller-cap drone manufacturers like Kratos Defense (KTOS).
• Small-Cap Biotech: Focusing on biotech companies with drugs in FDA Level 2 or 3 approval status, particularly those with catalyst events on the horizon (Indivier - INDV, focused on opioid treatment). A diversified portfolio of 30 names is recommended to mitigate risk.

Trending Tickers:

• Oracle (ORCL): Shares gained after TikTok’s parent company, ByteDance, signed a deal for a US joint venture managed by Oracle, Silverlake, and MGX. The deal is pending Chinese regulatory approval.
• Nike (NKE): Shares declined due to a disappointing outlook, citing weakness in China and the Converse brand. Revenue is expected to decline in the low single digits for the current quarter.
• FedEx (FDX): Shares rose following quarterly earnings that exceeded Wall Street estimates and an increased profit outlook, signaling success in the new CEO’s cost-cutting and network consolidation efforts.

Conclusion

The financial markets are poised for continued gains, with the banking sector leading the charge. AI is a transformative force, driving efficiency and innovation across the industry. Strategic investment in AI infrastructure, power solutions, defense, and carefully selected small-cap biotech companies offers potential for significant returns. Diversification and a focus on companies with strong fundamentals and catalyst events are crucial for navigating market volatility and capitalizing on emerging opportunities. The key takeaway is to “follow the money” and identify the companies positioned to benefit from these evolving trends.