As investors come to terms with the fact that the Federal Reserve is likely too boost interest rates next month, stocks and exchange traded funds that are positively levered to higher interest rates are regaining some of the appeal they lost following the Fed’s September decision to not increase borrowing costs.
Another sign that cements the notion that investors are preparing for higher borrowing costs is the price action in the SPDR S&P Regional Banking ETF (NYSEArca: KRE). All KRE, the largest regional bank ETF has done over the past month is surge 7.5%.
A rising interest rate environment will throw a wrench into the financial markets. Nevertheless, bank-related exchange traded funds could weather the storm as financial firms have positioned ahead of the potential rate changes. KRE’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]
“When it comes to investing in the regional banking sector, one of the most popular exchange traded funds used by retail investors is the SPDR KBW Regional Banking Index (KRE). Taking a look at the five-year weekly chart shown below, you can see that the index has been trading within and extremely strong uptrend and that the recent bounce off of the dotted trendline suggests that the trend is likely to continue. Investors who use technical analysis as part of their strategies will likely use the bullish crossover between the MACD indicator and its signal line as confirmation of the move higher and it is a sign that the bulls are in control of the momentum,” according to Investopedia.
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]
An improving U.S. economy could foster increased borrowing and financing by businesses, large and small, across the U.S. while benign mortgage rates could also provide a lift to the mortgage lending operations of regional banks.
SPDR S&P Regional Banking ETF
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.