It was not supposed to be this way this year for regional bank equities and the corresponding exchange traded funds. Amid expectations of multiple interest rate hikes by the Federal Reserve, regional bank stocks and ETFs surged following Election Day.
The Fed has done its job, boosting rates three times since Election Day, but regional bank ETFs are disappointing investors in epic fashion. For example, the SPDR S&P Regional Banking ETF (NYSEArca: KRE), the largest regional bank ETF, is down almost 7% year-to-date.
KRE and rival regional bank ETFs were banking on higher interest rates to boost their fortunes. 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.
With bond prices rising, meaning yields are falling, ETFs such as KRE are under pressure. The iShares 20+ Year Treasury Bond ETF (NYSEArca: TLT) is up 7%, underscoring the inverse correlation between longer-dated bonds and regional bank equities.
“Yields are pressing lower, and that’s taking that net interest margin earning capability away from the regionals,” Todd Gordon of TradingAnalysis.com said in an interview with CNBC.
Related: Sector ETF Plays to Keep on Your Radar Ahead
There are some obvious fundamental factors that bode well for U.S. debt ETFs, namely a slew of negative interest rate policies throughout the developed world, which make the low yields on U.S. bonds look all the more attractive.
“While KRE, the ETF that tracks regional banks, is still sitting near a $51 ‘support,’ Gordon said that if yields continue to fall, KRE could actually break below the $51 region and hit lows unseen since December of last year,” according to CNBC.
Aggressive traders can use the Direxion Daily Financial Bear 3X Shares (NYSEArca: FAZ), ProShares UltraPro Short Financials (NYSEArca: FINZ) and Direxion Daily Regional Banks 3x Bear Shares (NYSEArca: WDRW) to capitalize on any further downside from bank stocks and the broader financial sector.
Some analysts and traders argue that investors should be careful in making bullish bets on the financial services space, the S&P 500’s second-largest sector allocation, leading up to earnings season. In fact, analysts currently are not all that enthusiastic regarding bank stocks.
For more information on the financial sector, visit our financial category.