Aided by anticipation of and subsequent realization of higher interest rates courtesy of the Federal Reserve, financial services stocks and the corresponding exchange traded funds have been solid fourth-quarter performers. For example, the Financial Select Sector SPDR (NYSEArca: XLF), the largest financial services ETF, is up nearly 6% in the current quarter.
Earlier this month, banks including Wells Fargo & Co. (NYSE: WFC), JPMorgan Chase & Co (NYSE: JPM) and Bank of American Corp. (NYSE: BAC) raised their prime rates to 3.5% from 3.25%, Reuters reported. [Bank Stocks, ETFs Continue to Attract]
Prime rates are the interest rates that commercial banks charge credit-worthy clients and are typically determined by the federal fund rate, or overnight rate that banks lend to one another. Major banks hiked their prime rates in response to the Fed’s decision to raise its main short-term rate to a range of 0.25% to 0.5% from its previous range of 0% to 0.25%.
With higher interest rates in place and performances recently impressive, financial services ETFs enter 2015’s final week of trading as potentially important tells regarding what investors should expect from equities in 2016.
“The potential exposure of banks to the energy-dominated U.S. high-yield corporate bond markets has unnerved investors, and caused financial and energy shares to stall during the two trading sessions that followed the hike. Stocks in both those sectors have been closely correlated in recent weeks,” reports Reuters.
However, there is another important reason to consider bank stocks and ETFs: Rising profitability. In the case of regional banks, that profitability is expected to be enhanced if the Fed proceeds with boosting borrowing costs for the first time in nine years.
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.
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.
“Even if financials manage to decouple from oil, some market participants are not expecting any outsized benefits for the sector from the change in Fed policy, which is expected to be a gradual tightening of interest rates,” adds Reuters.
Financial Select Sector SPDR
