The Financial Select Sector SPDR (NYSEArca: XLF) is coming off one of its best annual performances since the global financial crisis.
While the financial services sector, the second-largest sector allocation in the S&P 500, has some doubters after last year’s impressive rally, some market observers believe the sector can keep tracking higher this year.
In addition to XLF, the largest financial services ETF, the SPDR S&P Bank ETF (NYSEArca: KBE) and SPDR S&P Regional Banking ETF (NYSEArca: KRE), among other exchange traded funds dedicated to bank stocks, have been soaring since early November.
KBE, KRE and friends are benefiting from speculation that the Federal Reserve will boost interest rates multiple times this year. 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.
The Fed is believed to be targeting three rate hikes in 2017 while Fed funds futures data currently imply the U.S. central bank will boost borrowing costs twice this year.
“Thanks to the post-election rally fueled by Donald Trump’s victory, the financials surged to finish the year up 20 percent from where the sector started in January. With JPMorgan hitting all-time highs in the first trading day of the year, Chad Morganlander, portfolio manager at Stifel Nicolaus, predicts that 2017 will be another banner year for the banks,” reports CNBC.
There is another important catalyst to consider for financial services stocks and ETFs: The potential for bullish earnings trends to emerge.
Higher interest rates would help widen the difference between what banks charge on loans and pay on deposits, which would boost earnings for the financial sector. Regional banks are among the stocks most positively correlated to rising interest rates because higher rates improve net interest margins.
“Along with the possibility of three interest rate rises in the coming year and Morganlander’s own observation that mortgage credit is starting to expand, both of which would also be good for banks, leads the portfolio manager to be overweight financials,” according to CNBC.
For more information on the banking sector, visit our financial category.