The Financial Select Sector SPDR (NYSEArca: XLF), the largest exchange traded fund dedicated to the financial services sector, is up just 2.2% year-to-date, a performance that trails the S&P 500 by a wide margin.
While financial services stocks and ETFs have been disappointments to this point in the year, that disappointment could be waning and now could be the time for investors to reconsider the sector.
There is some evidence to suggest the Federal Reserve’s three interest rate hikes over the past 16 months will benefit XLF and rival ETFs.
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. Although the Fed unveiled its first rate hike of 2017 last month, the central bank’s dovish tone punished regional bank stocks and ETFs.
Some of XLF’s biggest holdings “have some of the lowest valuations in the sector—and among large stocks in general—on earnings and price/book ratios. Big banks typically trade at lower valuations than regional and smaller ones because of greater complexity, tougher capital requirements, and more regulatory scrutiny,” reports Andrew Barry for Barron’s.
Some traders and investors are expressing concerns that the Trump trade is overbought, which makes the equities market vulnerable to quick turns.
Some are worried that House Republicans may not garner the necessary votes to replace the Affordable Care Act, or Obamacare, further fueling concerns over Trump’s ability to pass his planned tax cuts and deregulation initiatives, factors that fueled the late 2016 bounce in the financial sector. Still, bank profits are expected to rise.
“The profit outlook is looking up. Median earnings among larger banks are expected to increase by high-single digits this year, after growing just 2% in each of the past three years, according to Jason Goldberg, banking analyst at Barclays,” reports Barron’s.
The 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.
Some strategists also argue that the financial sector may be a good area to look at this time around, given the potential for growth in a rising rate environment, along with potential tax and regulatory changes under the Donald Trump administration.
For more information on the financial sector, visit our financial category.