Why Credit Card Stocks May Outperform in 2016

Credit card companies could be some of the best performing large cap stocks come 2016. Visa Inc. (NYSE: V), American Express Co. (NYSE: AXP), MasterCard Inc. (NYSE: MA) and Discover Financial Services (NYSE: DFS) should all be on investors’ radar for the coming year. Here’s why.

When the Federal Reserve raised its target rate to a range of 0.25% and 0.50% last week, what most media outlets failed to mention was that the new range was limited to what’s called required reserves. Much neglected was the fact that the Fed also raised the rate it pays banks to hold their excess cash from 0.25% to 0.50%. The importance of this second interest rate raise cannot be understated, because there are over $2.5 trillion of excess reserves already sitting at the Fed, a byproduct of the massive quantitative easing operations undertaken since the 2008 financial crisis.

These are two totally different rates. The rate on required reserves is what Federal Reserve member banks charge one another for overnight loans in order to meet daily reserve requirements. The rate on excess reserves is the rate at which the Federal Reserve itself pays banks to keep cash there and effectively out of the circulating money supply. In other words, out of the economy.

Why did the Fed raise rates on excess reserves as well as required reserves? Because if the rate on required reserves exceeds the rate on excess reserves, then that $2.5 trillion will start flying out of excess and into the economy in order to profit from the spread between the two rates. And that would mean an exploding money supply that could get out of control, resulting in high price inflation.
The significance of this for stocks is that if interest rate liftoff has indeed begun, then at some point possibly in the coming year, the rate on required reserves somewhere along the rate curve will exceed the rate on excess reserves, and the extra money will begin to flood into the economy. That will lead to a booming stock market, as expanding money supply tends to do. So why credit card companies specifically?