The Financial Select Sector SPDR (NYSEArca: XLF) and other financial services exchange traded funds are among the more disappointing sector-level plays this year, particularly after the Federal Reserve boosted borrowing costs last month.
A subsequent dovish tone from the Fed weighed on financial services, the S&P 500’s second-largest sector weight. As a result, XLF is up just 2% this year. With first-quarter earnings season right around the corner, some market observers believe investors should be careful in betting that earnings will meaningfully impact financial services ETFs.
“As we head into quarterly results, our expectations have been lowered, but we remain optimistic near-term that bank fundamentals will continue improving–led mostly by higher rates,” according to part of a KBW note posted by Crystal Kim of Barron’s.
KBW has mixed views on first-quarter results for some of XLF’s biggest holdings. The research firm is “raising first-quarter earnings estimates for Bank of New York Mellon (BK), State Street (STT), and Wells Fargo (WFC). He is lowering estimates for Bank of America (BAC), Citigroup (C), Goldman Sachs (GS), JPMorgan Chase (JPM) and Morgan Stanley (MS),” according to Barron’s.
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.
The financial sector is getting hit by a double whammy as more are growing concerned over Trump’s ability to deliver on promises and yields on Treasury bonds pulled back. 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.
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.
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.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.