ETF Trends
ETF Trends

The Financial Select Sector SPDR (NYSEArca: XLF) is off 14% year-to-date, making it the worst-performing sector SPDR exchange traded fund this year and it appears investors are growing pensive about the near-term outlook for the financial services sector.

Contributing to the weakness in the bank sector, traders may have been unwinding bullish bets in the run-up to the Federal Reserve’s first rate hike in December, reports Stephen Foley for the Financial Times. Investors hoped that higher rates would allow banks to capitalize on wider net interest margin – the difference between deposit rates and lending rates, but the global economic uncertainty has weighed on prospects for a quick Fed rate hike schedule.

While U.S. banks have some exposure to over-leveraged oil companies, the level of exposure to the distress energy industry is not up to the scale of the U.S. housing market that triggered the 2008 run. Nevertheless, market observers are weighing on the oil outlook in the recent earnings season.

“While options prices have also been rising for the market as a whole, the increasing concern around the banks has been notable. As the below chart from Rareview Macro strategist Neil Azous shows, the implied volatility of Bank of America shares has risen precipitously compared to the implied volatility of the S&P 500 (as commonly measured with the VIX),” reports CNBC.

More pressing is recent price action in financial services stocks and ETFs, which highlights the group’s vulnerability to a flattening yield curve. One point of attraction for XLF and rival financial services ETFs has been the discounted valuations of big bank stocks.

Previously, 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.

“Of course, the nervousness extends beyond American banks. Perceived weakness in European financials such as Deutsche Bank appears to have become on of the market’s biggest preoccupations,” according to CNBC.

Financial Select Sector SPDR

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.