The financial sector has certainly come a long way since the bailouts and losses of the crisis. The progress made in just five years has been pretty impressive, to say the least. Banks are much better capitalized, asset qualities have improved, and financial-services companies are now growing in the right ways.
However, much of the financial sector is still vulnerable. Here are three scenarios that could cause the Financial Select Sector SPDR Fund (NYSEMKT:XLF) to fall in 2015.
The stock market could fall
This may seem like an obvious reason, and on one level it is. After all, if the overall stock market drops by 10%, we can expect shares of our favorite financial firms to do the same, even if there are no fundamental changes in their businesses.
However, a drop in the stock market could hit the financial sector particularly hard. For example, one reason investment banks like Goldman Sachs and Morgan Stanley have been performing so well lately is that M&A and IPO activity has been exceptionally high thanks to the market's good performance.
When stock prices are high, companies are more likely to agree to be bought out, and private companies have more of an incentive to go public because they can command higher prices for their shares. A significant drop in the markets could change that.
Further, brokerages make a lot of their money on fees and commissions. Let's say a certain brokerage has $100 billion in client investment accounts. If the overall stock market falls by 10%, that's $10 billion less under management that can generate commissions going forward.
Interest rates could rise
The big banks' excellent performance over the past few years has owed partly to an increase in lending, particularly in auto loans and credit cards. The improving job market has given the public more disposable income, and this, combined with low interest rates, has produced a massive increase in borrowing.
However, if interest rates increase significantly, it could drastically hurt the banks' lending businesses. Wells Fargo, Citigroup, JPMorgan Chase, and Bank of America all have rather large credit card and other lending businesses, and these four companies combine to make up more than 27% of the Financial Select Sector SPDR Fund's holdings.
Low oil prices could hit the banks hard
In some ways, cheap oil can be good for the banks. Consumers pay less at the pump and therefore have more money in their wallets -- which means they could be more inclined to use their credit cards and take out loans for things like cars.
However, the negative aspects of cheaper oil can completely negate any benefits. According to CNBC, energy companies make up between 15% and 20% of U.S. junk debt -- much of which is on the books of banks -- and it's entirely possible for the oil collapse to cause defaults. Plus, banks are "market makers" in bonds, meaning they rely on healthy demand in the bond market, which could fade if bond prices fall as a result of lower oil prices.
So far, so good
It's hard to make a solid case against the financial sector if everything keeps progressing as it has been in terms of the economic recovery, stock market performance, and interest rates.
However, there are a few scenarios, including the ones I mentioned here, that could cause the financial sector to decline. In investing, it's important to know the risks involved, and these are three big risks facing the Financial Select Sector SPDR Fund.
Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends Goldman Sachs. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.