Nearly 10 financial services exchange traded funds made new highs Thursday, extending a bullish run that has seen the sector recently become an investor favorite.
Rising Treasury yields have been a driving force behind financial services sector ebullience. Yields on 10-year government bonds have climbed 19% over the past 90 days and 23.5% this quarter, helping boost ETFs such as the Financial Select Sector SPDR (NYSEArca: XLF), SPDR S&P Regional Banking ETF (NYSEArca: KRE) and the SPDR S&P Bank ETF (NYSEArca: KBE).
Put simply, interest rates play a significant role in investors’ attitude toward bank stocks and ETFs. KRE is a prime example of that. That ETF’s sensitivity to interest rates is well known. The ETF rose just 2% last year after surging 47% in 2013 when yields spiked. KRE’s holdings have an average beta of +0.44 to moves in the US 10 Year Treasury. [Look to Bank ETFs in a Rising Rate Environment]
That is good news, but there is more where that came from for bank stocks and the aforementioned ETFs.
“Industry analysts are mostly very optimistic about the outlook for earnings growth for the S&P 500 and most of its sectors. The consensus expected long-term earnings growth rate (LTEG) over the next five years is 10.3% per year on average,” according to Yardeni Research.
The research firm notes that in terms of LTEG, financial services expectations are the third-highest among all sectors, trailing only consumer discretionary and technology. Financial services as a group has a short-term earnings growth rate of 13%, trailing only consumer discretionary, according to Yardeni.
With that, it would be reasonable to surmise that financial services are boosting bottom lines and that appears to be the case. Yardeni Research notes profit margins for the sector are at new cyclical highs and flirting with all-time highs last seen in 2007.
The impact has been palpable. XLF, the largest financial services ETF by assets, is up 4% this month, betraying ominous seasonality that usually sees the fund rank as the worst of the nine sector SPDRs in June. [Bad Sector ETFs in June]
That after investors added $545 million to XLF last month. KRE captured $243.4 million in new investments last month while KBE hauled in almost $90 million.
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. [Muted Bank ETF Expectations]
Through June 17, investors had poured $1.27 billion into XLF this month. KRE and KBE pulled in $352.5 million and $176.7 million, respectively.
Financial Services LTEG
Chart Courtesy: Yardeni Research