Financial services, a sector largely dependent on the U.S. for a significant chunk of its revenue, is being punished due to the coronavirus outbreak and that repudiation was on full display when the Federal Reserve unveil an emergency interest rate cut of 50 basis points.
The news sent the Financial Select Sector SPDR (NYSEArca: XLF), the largest financial services ETF, lower by 3.76% while the SPDR S&P Regional Banking ETF (NYSEArca: KRE) dipped about 4.15%.
“Stocks snapped back into sell-off mode on March 3 with banks again outpacing the broader market indexes. Analysts wrote that the market had been pricing bank stocks on the likelihood of a Federal Reserve rate cut, which came through on March 3 in the form of a 50-basis-point reduction in the benchmark rate,” reports S&P Global Market Intelligence.
Banks rely on interest rates for profits and naturally, the higher, the better. The problem for banks is that their profit margins could suffer if they are paying out deposit rates at a higher level than market rates. Their earnings are also damaged when the spread between short-term and long-term rates flattens, a phenomenon that could likely worsen if the Fed cuts further.
Hope Springs Eternal
Rising interest rates historically benefit regional banks. 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.
Obviously, KRE and rival regional bank ETFs aren’t going to be treated to rising rates anytime soon, but some analysts see opportunity with select names in the industry, some of which can be found on KRE’s roster.
“B. Riley FBR analysts Steve Moss and Nicholas Duafala wrote in a March 3 note that a rate cut by the Federal Reserve is likely to favor banks with rate-sensitive liabilities,” reports S&P Global Market Intelligence. “The analysts named Bloomington, Minn.-based Bridgewater Bancshares Inc. and Irvine, Calif.-based First Foundation Inc. as top picks due to liability-sensitive balance sheets and conservative credit culture. They also had San Diego-based Axos Financial Inc. as a top pick for its attractive valuation and unique business model.”
Bottom line: if markets can show a sustainable rebound and if the Fed eschews another rate cut at its meeting later this month, there could be some runway for KRE and XLF to bounce back.
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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.