Despite an upbeat earnings season and low exposure to the current round of economic risks, U.S. bank stocks and sector-related exchange traded funds have underperformed, potentially opening up a buying opportunity for value investors.
Year-to-date, the SPDR S&P Regional Banking ETF (NYSEArca: KRE) fell 12.6%, iShares U.S. Regional Banks ETF (NYSEArca: IAT) dropped 10.9% and PowerShares KBW Regional Bank Portfolio (NYSEArca: KBWR) decreased 9.9%. 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) both declined over 12% year-to-date. 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.
The underperformance in the banking sector has dragged on the broader financial sector, with the Financial Select Sector SPDR (NYSEArca: XLF), which includes a 35.3% tilt toward banks, down 8.9% year-to-date, compared to the S&P 500’s 5.0% drop.
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.
The options market is also pointing to a sharp increase in the cost of insurance against a banking sector meltdown. Currently, options predict a worst-case scenario of a 28% plunge in financial stocks over the next three months, according to Myron Scholes and Ashwin Alankar, the options markets experts at the asset manager Janus Capital.
“I cannot identify a big source of risk,” Alankar told the financial times, “but the market is seeing something. I worry we could be missing something.”
On the other hand, the markets may be trying to discern shapes in the shadows where there are none, overreacting to the recent spate of economic weakness. For instance, banking analyst Mike Mayo argues that Wall Street banks are trading at “recession prices but no recession.” On a price-to-tangible book value, banks have dipped to levels below pre-financial crisis, and some bank stocks are now trading below book value.
Max Chen contributed to this article.