Bank stocks and sector-related exchange traded funds have been pulling ahead in the financial space, but investors should not get overzealous with their bets.
Year-to-date, the SPDR S&P Regional Banking ETF (NYSEArca: KRE) rose 4.8%, iShares U.S. Regional Banks ETF (NYSEArca: IAT) gained 3.6%, PowerShares KBW Regional Bank Portfolio (NYSEArca: KBWR) increased 4.6%, SPDR S&P Bank ETF (NYSEArca: KBE) advanced 5.1%. Meanwhile, the Financial Select Sector SPDR (NYSEArca: XLF) added 0.9% and SPDR S&P 500 ETF (NYSEArca: SPY) returned 3.9% so far this year.
Bullish investors may look to banks as the industry is now well capitalized, dividends are on the rise and continued growth favors the cyclical sector, writes John Authers for Financial Times.
Moreover, some argue that financials look cheap after the sector largely underperformed the broader market since the financial crisis.
On the other hand, some factors may keep a lid on future gains. For instance, the slew of post-crisis regulation has dampened profits and low interest rates have kept banks from many money from interest margins.
Regulatory concerns have also kept mergers and acquisitions activity among banks at bay while other sectors, notably healthcare companies, are seeing deals go through at pre-crisis levels, which have helped contribute to stronger gains.
Bank valuations are also back up. Looking at price-to-book multiples, the most popular measure for valuing the sector, U.S. banks of the KBW banks index are trading near fair value at a 16% premium to book value, or about the same valuations in the summer of 2008. The sector has shown it is capable of trading a even higher valuations of three or even five times book value, but banks are unlikely to return to the late 199s levels.
Authers also pointed out that the financials are not a contrarian play that many bulls are looking for as many investors have overweight the sector. According to Bank of America Merrill Lynch, institutional investors are collectively overweight financials around the world, and in the U.S., institutions are now the third highest overweight in banks since 2006.
For more information on the financial sector, visit our financial category.
Max Chen contributed to this article.