Financial services exchange traded funds, including the Financial Select Sector SPDR (NYSEArca: XLF) and the SPDR S&P Bank ETF (NYSEArca: KBE), have not been investor favorites this year. With U.S. interest rates remaining low and the Federal Reserve seemingly not on course to do anything about that anytime soon, pressure remains on the S&P 500’s second-largest sector allocation.
Said another way, one the primary catalysts that previously lured investors to bank ETFs, that being speculation of higher interest rates, is largely off the table. With a steepening yield curve, or wider spread between short- and long-term Treasuries, banks could experience improved net interest margins or improved profitability as the firms borrow short and lend long.
Related: Financial Sector ETFs Maintain Momentum
However, there are some signs that traders are nibbling at bank ETFs. The financial sector received a boost from Presidential candidate Donald Trump after he proposed dismantling nearly all of Dodd-Frank, the package of financial reforms placed after the global financial crisis. However, the Fed has proved uncooperative when it comes to boosting rates and the latest FOMC minutes reveal the central bank’s concerns about the labor market, decreasing the likelihood of near-term rate hikes.
“In the past week I have seen multiple large January 2018 out of the money call purchases across the Financial sector, looking to take advantage of the cheapness of upside calls (skew). This usually occurs when smart money is positioning for a trend move. Another potential factor for outperformance is that in the later innings of a bull market, and we clearly are in one of the longer ones right now, there will be a natural rotation to value from growth, which the Banks offer,” according to See It Market.
[related_stories]Heading into this year, many market observers expected four Fed rate hikes, a number that subsequently dropped to two and now, in the eyes of some experts, zero.
ETFs such as the Financial Select Sector SPDR (NYSEArca: XLF), iShares U.S. Financials ETF (NYSEArca: IYF) and the Vanguard Financials ETF (NYSEArca: VFH) have been under pressure following the Brexit outcome, but there are other factors at play, including the Federal Reserve’s refusal to raise interest rates to this point in 2016.
Related: Financial Sector ETFs Plunge on Brexit Contagion
“It is no wonder why the group trades at such a low multiple to other sectors considering the historically low interest rates, as Banks’ earnings are directly correlated to the Federal Funds rate. A rising rate environment also correlates with a strong economy, and translates to rising loan demand, and greater profitability on loans,” adds See It Market.
Financial Select Sector SPDR
