The Financial Select Sector SPDR (NYSEArca: XLF), the largest financial sector exchange traded fund, is in the midst of a solid run as highlighted by a fourth-quarter gain of over 5%. Some technical analysts believe more upside is coming for resurgent financial services stocks.
Looking ahead, a number of factors could continue to support the financial sector. For instance, the Federal Reserve has expressed intention to raise rates, tighten monetary policy. Banks’ most basic profit-making business model is to take on deposits and issue loans, so higher interest rates means higher rates on loans, which translates to improved profit margins.
“The strength in bank stocks signals to Ari Wald, head of technical analysis at Oppenheimer, that ‘the bad news has been priced in for the financial sector, that the strong hands do not want to give up their banks.’ In other words, banks could be your best bet heading into the rest of the year,” reports CNBC.
As conditions improve, the Federal Reserve will tighten its monetary policy to obviate an overheating economy. The central bank has already outlined plans to start winding down its trillion dollar balance sheet in October and left a December rate hike open.
BlackRock also argued that U.S. regional banks could benefit the most as they tend to have a larger share of businesses in traditional banking services, such as loans and deposits, compared to their larger peers.
Related: Looking Ahead for Breakouts in Financial Sector
Looking ahead, analysts project U.S. bank earnings to expand 12.8% in 2018, and BlackRock sees “scope for this number to improve.” Furthermore, the sector is trading at cheap valuations, with U.S. banks discounted by 24% compared to 5% for European banks.
“As sentiment starts to curl the other way, as expectations start to turn toward higher rates, we think the financial sector is in a terrific position to start to outperform again and break out to the upside,” Wald said, reports CNBC.
Financials are widely viewed as the one sector in the U.S. that has the look of a legitimate value opportunity. Investors have added $1.1 billion to XLF since the start of the fourth quarter.
Rivals to XLF include the Fidelity MSCI Financials Index ETF (NYSEArca: FNCL), iShares U.S. Financials ETF (NYSEArca: IYF) and Vanguard Financials ETF (NYSEArca: VFH).
For more information on the financial sector, visit our financial category.