The Financial Select Sector SPDR (NYSEArca: XLF), the largest exchange traded fund tracking the financial services sector, is higher by more than 7% year-to-date.
XLF and other financial services ETFs have had the wind at their backs due in large part to speculation that President Donald Trump’s policies will be kind to the S&P 500’s second-largest sector weight.
The Trump administration’s expansionary policies would be especially beneficial for banks since the segment is sensitive to the overall economy. Moreover, the expansionary policies have fueled bets of increased Federal Reserve interest rate hikes to rein in a potentially overheating economy and rising inflation, which further supports lending revenue and their bottom line among bankers and insurers.
Bank ETFs 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.
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.
Then there is speculation that the Trump Administration’s efforts at tax reform could boost bank earnings.
“The timing and nature of any corporate tax changes remains uncertain; whether any tax savings would be retained is unclear. Under pro forma assumptions, ROAs would increase to varying degrees, as illustrated with 25% and 20% effective tax rate scenarios – see table below. The effective tax rate for all US bank holding companies was 30% as of 3Q16,” said Fitch Ratings in a recent note.
Some analysts believe investors’ new found faith in the financial services sector will ultimately be rewarded. XLF and rival financial services ETFs have been bolstered this year after President Donald Trump revealed plans to scale back 2010 Dodd-Frank legislation, which increased regulations on banks and financial services companies following the global financial crisis.
“Any DTA reductions would be reflected as a charge through income tax expense in the revaluation period, which would have a negative effect on earnings and equity. Conversely, downward adjustments to DTLs would decrease income tax expense and have a positive effect. Therefore, banks with net DTL positions may benefit the most from a change in the federal tax rate,” adds Fitch.
For more information on the financial sector, visit our financial category.