Why Financial ETFs Are Healthier Than Recent Action Suggests

The Financial Select Sector SPDR (NYSEArca: XLF), the largest financial services ETF, is lower by more than 5% this week. That’s ugly price action to be sure, but it may also belie significant opportunity with bank stocks.

Market observers have previously warned that Wall Street banks could face pressure as tepid market volatility could have contributed to more muted trading desk activity. Furthermore, the Federal Reserve has signaled its intentions to cut interest rates, which would further hurt the banking industry’s ability to generate profits from lending. However, some investors believe some of XLF’s marquee components could actually benefit from lower rates.

Some analysts believe that the current value being offered by bank stocks may prove too compelling to ignore.

“U.S. bank stocks have recession prices without a recession,” said Wells Fargo analyst Mike Mayo in an interview with CNBC. “Valuations sure are attractive here.”

That value proposition could increase the allure of ETFs, such as the SPDR S&P Bank ETF (NYSEArca: KBE).

Bank Sector Concerns

With the capital markets possibly expecting a cut in interest rates, could this affect banks’ lending businesses to the point where they suffer? Some analysts question whether the sector strength can continue through the rest of 2019. During second-quarter earnings season, banks frequently guided lower on net interest margins.

“There is likely to be near-term pain if the current rate environment stays at the current level,” Mayo said. “There could be a little pain as people incorporate potentially lower earnings estimates into the next quarter ahead.”

Related: A Sector ETF With Surprise Rate-Cut Upside Potential

One thing to consider is that U.S. banks generate massive percentages of their revenue and earnings on a domestic basis, indicating the group has been perhaps unfairly battered as the broader market has declined due to trade tensions. Overall, bank stocks and ETF like KBE and XLF may be cases of short-term pain, long-term gain.

“Look, there are tail risks in both directions,” said Mayo in the CNBC interview. “So, short-term caution, [but]long-term phenomenal opportunity.”

For more information on the financial sector, visit our financial category.