Flailing Financials Could Shine a Light on This Broad Market ETF

Financial services stocks were punished along with the rest of the broader market during the February, coronavirus-induced swoon. For example, the S&P 500 Financial Services Index is lower by 8.66% over the past month.

There’s a lesson there: many traditional, plain vanilla, broad market equity funds are heavily allocated to the financial services sector because that’s the third-largest sector allocation in the S&P 500. Lesson number two is investors should be aware of that a time when global central banks are rumored to be mulling coordinated policy response to the coronavirus epidemic.

Should that scenario materialize, it could shine a light on the ProShares S&P 500 Ex-Financial ETF (NYSEArca: SPXN). SPXN follows the S&P 500 Ex-Financials & Real Estate Index.

The exclusion of financials is meaningful when the time is right. Year-to-date, SPXN is outpacing traditional S&P 500 ETFs by 40 basis points.

“An investment in the S&P 500 that excludes a particular sector gives you the flexibility to tailor your core U.S. equity exposure,” according to ProShares. “It can replace a traditional S&P 500 fund, allowing you to underweight or even eliminate a sector in your portfolio.”

Why Now For SPXN

SPXN could merit near-term consideration even as traditional beta products rebound.

“Lower longer-term rates and the potential for an emergency Fed rate cut in response to growing fears of economic slowdown due to the global coronavirus (COVID-19) outbreak could challenge profitability for U.S. banks into 2020 and beyond,” says Fitch Ratings. “If the COVID-19 outbreak is quickly contained, the disruption is not expected to have a material effect on the creditworthiness of U.S. banks. However, a prolonged severe disruption could negatively affect bank earnings, capital levels and ultimately ratings.”

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.

“Softer profitability during the year was already expected due to a more challenging rate environment, continued compression in fee margins and a lessened ability to find expense relief as the need to invest in technology continues,” according to Fitch. “A prolonged economic slowdown leading to increased company defaults and higher loss provisions, supply chain disruptions or a reduction in travel would further pressure banks, which could alter risk appetites in a search for yield, which would be viewed negatively from a credit perspective.”

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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.