The Financial Select Sector SPDR (NYSEArca: XLF) finished 2016 higher by nearly 23%, good for one of the best showings among non-leveraged sector exchange traded funds.
XLF and rival financial services ETFs were boosted in the fourth quarter by multiple factors, including Donald Trump’s surprise victory in November’s presidential election and the Federal Reserve’s first interest rate increase of 2016, which arrived last month.
In addition to corporate tax reductions, Trump is looking to ease the regulatory burdens faced by many of the big name companies in ETFs like XLF.
Trump has said he would “dismantle” financial reform, or the Dodd-Frank financial reforms, that have caused big banks to take on increased capital requirements to obviate another depression event associated with high-risk debt.
Bank stocks and ETFs are benefiting from speculation that the Federal Reserve will finally raise interest rates three times in 2017. 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.
Some market observers see the second-largest sector allocation in the S&P 500 as being a valid bullish play for the last three months of the year. Good news: Analysts see more good things on the horizon for banks stocks in 2017.
However, some technical analysts believe the sector has gotten too hot too fast.
“The recent breakout and massive rally higher has pushed relative momentum up to levels seldom seen in the past 10 years. If past history is an indicator of future results, then the banking sector could underperform for the next 1 to 3 years,” according to See It Market.
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.
“Lastly, at the same time that momentum is overheated, the Bank Index/S&P 500 ratio is testing “dual” price resistance,” adds See It Market.
For more information on the banking sector, visit our financial category.