The Financial Select Sector SPDR (NYSEArca: XLF), the largest exchange traded fund dedicated to the financial services sector, and some rival financial services ETFs have traded lower this week. That could be seen as a negative following the Federal Reserve raising interest rates last week, but there are positive fundamental signs for the financial services sector.
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.
“Earnings for banks and other companies in the Financials sector are particularly sensitive to higher interest rates. Given this rate increase marked the third rate hike in the past six months, have analysts been increasing their EPS estimates for 2017 for banks and other companies in the S&P 500 Financials sector over this time frame?,” according to FactSet research.
The good news for financials is that the sector, the second-worst performer this year behind only energy, is widely regarded as perhaps the only sector in the U.S. that is attractively valued relative to the broader market and its own long-term averages.
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.
Some bond traders expect the Fed to raise rates again later this year which could give XLF and rival ETFs another boost. Additionally, market observers are forecasting three rate hikes by the Fed in 2018.
“In terms of EPS estimate revisions, 38 of the 65 companies (58%) in the S&P 500 Financials sector have seen an increase in their mean EPS estimate for 2017 since December 31. Three of the four sub-industries in the Financials sector with the largest percentages of companies that have recorded an increase in their mean EPS estimate for 2017 (since December 31) are bank-related sub-industries: Investment Banking & Brokerage, Diversified Banks, and Regional Banks,” according to FactSet.
For more information on the financial sector, visit our financial category.