Sound Fundamentals Support Bank Stock, ETF Bonanza | ETF Trends

As many investors know well by now, bank stocks and the related exchange traded funds are proving to be stellar trades this year.

For example, the Invesco KBW Bank ETF (NASDAQ: KBWB) is up nearly 42% year-to-date and hit near-record highs on Oct. 19. For KBWB, which tracks the KBW Nasdaq Bank Index, this move is about more than rising Treasury yields. Sure, that helps, but the bulk of 10-year yields’ upside occurred in the first half of the year and in recent weeks while KBWB, though not in straight line fashion, is grinding higher for much of this year.

This indicates that KBWB’s 2021 ascent is rooted in stout fundamentals, as highlighted by impressive third-quarter earnings reports from some of the fund’s marquee components.

“In recent days, heavyweights like JPMorgan Chase (JPM) and Bank of America (BAC) solidly beat earnings expectations for the third quarter. Bank of America, along with Wells Fargo (WFC), is up more than 7% since reporting earnings. Against this strong earnings backdrop, for six of the largest banks, Morningstar analysts have raised their estimates of the stocks’ value,” according to Morningstar.

With just over two months remaining in 2021, financial services ranks as the second-best sector, trailing only energy. That’s an impressive turnaround from last year when bank stocks were hammered by the Federal Reserve slashing interest rates, the central bank preventing banks (including KBWB components) from boosting dividends and forcing those companies to set aside cash for sour loans amid expectations that the coronavirus recession would be lengthy and severe. In fact, reversing those reserves is helping bank stocks this year.

“One factor giving a boost to bank profits has been the reversal of 2020’s loan-loss reserves set aside amid the recession,” adds Morningstar. “When banks set aside provisional cash to cover any loans that go bad, two things can happen to these reserves: If loans are repaid, the reserves get added back to the balance sheet as earnings, and if loans go bad, the reserves get converted to losses in the form of net charge-offs.”

After this year’s mighty rally, only a handful of KBWB member firms are attractively valued, but valuation alone isn’t a reason to buy or sell a stock. Plus, the ETF and its components still have catalysts.

“One potential positive for banks going forward are rising interest rates, which translate into higher net interest margins–essentially the difference between what banks can lend versus the cost of borrowing,” adds Morningstar.

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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.