The Financial Select Sector SPDR (NYSEArca: XLF), the largest exchange traded fund dedicated to the financial services sector, rose 1.3% last week. Perhaps some of that ebullience is attributable to expectations of the Federal Open Market Committee (FOMC) raising interest rates when it meets later this week, but this is a movie investors have seen before and it could leave them disappointed.
After all, the Fed raised rates in March, but after sounding a surprisingly dovish tone, the U.S. central bank sent XLF and rival financial services ETFs on a path of mediocrity this year. In fact, only the energy sector is performing worse than financial services this year.
Some bond traders expect the Fed to raise rates again, perhaps as soon as this month, which could give XLF and rival ETFs a near-term boost. However, investors should temper their expectations for big gains by bank ETFs this week.
“XLF call options are flying off the shelves. However, buyers should beware, if recent history is any indicator: bank stocks tend to underperform during Fed weeks, and the highly anticipated Federal Open Market Committee (FOMC) meeting is right around the corner. Below, we’ll take a closer look at XLF, as well as three finance stocks that could fall short,” this week, reports Schaeffer’s Investment Research.
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 in March, the central bank’s dovish tone punished regional bank stocks and ETFs.
The SPDR S&P Regional Banking ETF (NYSEArca: KRE), the largest regional bank ETF, would also like to see higher interest and a more hawkish Fed.
KRE and rival regional bank ETFs were banking on higher interest rates to boost their fortunes. 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.
“However, not only is the Financial Select Sector SPDR Fund the worst ETF to own in the month of June, it’s also the worst to own the week of a Fed meeting. In the past 10 years, XLF has lost an average of 3.4% in the month of June, according to data from Schaeffer’s Senior Quantitative Analyst Rocky White. In Fed weeks since 2015, the XLF has averaged a loss of 1.38% — the absolute worst — with a win rate of just 37%,” according to Schaeffer’s.
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