Are Financials the Hidden AI Trade?

Financial stocks have been strong performers in 2025 and continue to impress so far this year. The XLF financials ETF has risen 13.6%, driven by substantial gains from major banks such as Wells Fargo, which returned 23.2%, and JPMorgan Chase, up 21.4%. Among smaller holdings, Citigroup notably surged more than 70%.

While much of 2025’s market focus was on “who builds the chips” powering artificial intelligence, in 2026 the attention is shifting to “who uses the chips to streamline operations.” Financial institutions are expected to be among the early adopters of AI technology, which could strongly boost their profitability. Today, the XLF is up 2.7%.

Banks possess two critical ingredients for AI to generate profit: vast amounts of complex data and costly, repetitive labour. According to Citigroup’s own research, approximately 54% of roles within banking face displacement from AI. If Citi were to reduce its workforce by 20,000 to 25,000 employees (roughly 10% of its 230,000 staff), it could save around $2.5 billion annually—translating into a 12-14% increase in post-tax earnings per share.

Returns from AI will not only come from cutting costs. Improvements in lending and risk management are also anticipated. More accurate AI-driven assessments of borrower creditworthiness could lead to far more profitable lending. Similar benefits may extend to insurance and capital markets.

However, traders should be cautious. The market may be overestimating the benefits of AI-related efficiency gains while underestimating the risks to lending. If AI and robotics lead to 10-20% reductions in employment across the broader economy, rising unemployment could negatively affect loan performance and bank profitability.

At present, many of the positive effects are priced into financial stocks, a trend likely to continue through 2026, particularly in those banking shares that were undervalued at the start of the year.

Original Source: Adam Button of investinglive.com