With the Federal Reserve just days away from possibly raising interest rates for the first time in nine years, it is not surprising that investors continue embracing financial services stocks and the relevant exchange traded funds.
It also is not surprising that market observers continue lavishing bullish praise on the second-largest sector weight in the S&P 500 ahead of the possible rate hike.
For bank exposure, ETF investors have a number of options to choose from, including the SPDR S&P Regional Banking ETF (NYSEArca: KRE), iShares U.S. Regional Banks ETF (NYSEArca: IAT) and PowerShares KBW Regional Bank Portfolio (NYSEArca: KBWR). These regional bank ETFs all include greater tilts toward smaller banks.
Additionally, the SPDR S&P Bank ETF (NYSEArca: KBE) and PowerShares KBW Bank Portfolio (NYSEArca: KBWB) lean toward larger companies. KBWB follows a market cap-weighted index, which make the index heavy on prominent banking names. KBE, on the other hand, tracks an equal-weight indexing methodology, so the ETF will include a greater tilt toward mid-cap banks. [4 Reasons to be Optimistic about Bank ETFs]
“In the past, bank stocks underperformed the overall market while the Fed raised short-term interest rates. That’s because rising short-term interest rates, combined with stable long-term rates, have almost always led to narrower net interest spreads, which is the profit rate that banks make on loans. Once the Fed has finished hiking short-term rates, however, long-term rates have typically risen, leading to wider net interest rate spreads, and bank stock outperformance,” according to a note from S&P Capital IQ posted by CNBC.
KRE, the largest regional bank, is the more correlated to changes in interest rates than the Financial Select Sector SPDR (NYSEArca: XLF), the largest financial services ETF.
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]
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
