Few if any sector exchange traded are as levered to Federal Reserve action as are financial services ETFs. So even though the Fed did not raise interest rates this month, the Financial Services Select Sector SPDR (NYSEArca: XLF) and rival funds could be worth examining because many traders believe a December rate hike is certainly on the table.
The Federal Reserve’s decision to hold off on an interest rate hike, ongoing economic weakness and concerns over trading revenues have weighed on the financial sector’s outlook.
Given the recent spike in volatility, market participants anticipate larger swings than usual this earnings season. While bank shares move about 2% after an earnings announcement, swings one-and-a-half times the average are expected ahead.
One point of attraction for XLF and rival financial services ETFs has been the discounted valuations of big bank stocks. However, the cheapness of U.S. banks belies the strength of the financial sector. Over few years, banks have shed unprofitable businesses and assets while bulking up capital to return some to shareholders through stock buybacks and dividends, the Wall Street Journal reports.
“One immediate impact of the failure to raise interest rates is that it caused the value of bank assets to rise and it improved real book values. This is because an estimated 92 percent of bank assets are financial instruments. If interest rates remain stable or decline slightly, the value of these assets rises in real terms. This improves banking industry book value,” said Dick Bove of Rafferty Capital Markets in a note cited by Jeff Cox of CNBC.
And when it comes to higher interest rates bolstering financial services ETFs such as XLF, the good news is that the number of traders betting that the Fed will boost borrowing costs following its December meeting has climbed in recent days. Options traders are buying into the notion of higher rates benefiting bank stocks.