Factors to Fuel Financial ETFs' Continued Outperformance

Financial stocks and sector-related exchange traded funds have finally been able to pull ahead after years of underperforming the broader equities market, but how much further can they go?

Over the past year, the Fidelity MSCI Financials Index ETF (NYSEArca: FNCL) gained 42.3%, Financial Select Sector SPDR (NYSEArca: XLF) rose 42.1%, iShares U.S. Financials ETF (NYSEArca: IYF) added 32.5% and Vanguard Financials ETF (NYSEArca: VFH) was up 42.4%. In contrast, the S&P 500 index was 21.7% higher over the past year.

Meanwhile, the iShares U.S. Regional Banks ETF (NYSEArca: IAT) advanced 52.4%, SPDR S&P Regional Banking ETF (NYSEArca: KRE) jumped 54.9%, PowerShares KBW Regional Bank Portfolio (NYSEArca: KBWR) surged 47.2% and SPDR S&P Bank ETF (NYSEArca: KBE) increased 51.8%.

“As a cyclical, value sector, and arguably the only one that can directly benefit from rising interest rates, financials should be performing well. This case for financials becomes stronger if you assume some dialing back in financial regulation as the Trump administration promises,” Russ Koesterich, Portfolio Manager for BlackRock’s Global Allocation Team, said in a note.

The sector has benefited from the build up of enthusiasm and optimism over the economic outlook, but some traders may be worried about the higher valuations after the recent run up in the sector – Koesterich pointed out that the price-to-book on the sector is up over 40% from last summer’s lows.

Nevertheless, financial sector valuations still look relatively cheap, compared to the broader market. The sector’s valuations are still about 25% below the average since the early 1990s.