Financial services stocks and related bank ETFs were one of last year’s hottest sector trades and a group that started 2018 in impressive fashion, but scenario has rapidly reversed.
For example, the Financial Select Sector SPDR (NYSEArca: XLF), the largest exchange traded fund tracking the financial services sector, is down more than 3% over the past week and nearly 5% this month.
Making that scenario all the more surprising is that the Federal Reserve raised interest rates last week, prompting many market observers to speculate that as many as three more rate hikes could be coming this year. Additionally, the financial services sector, the second-largest sector weight in the S&P 500, has had the regulatory wind at its back this year as the Trump Administration has sought to roll back parts of the Dodd-Frank legislation.
Related: U.S. Sector ETFs for a Rising Rate Environment
Deregulation could also help the financial sector improve their margins. President Donald Trump has shown its eagerness in cutting back the red tape and remove some of the post-financial crisis regulations that has stifled the industry. The rising interest rate environment is also good for net interest margins for banks and more so for insurance companies.
What’s Holding Back Banks
“While the broader market has been hit considerably, and banks are participating in that decline, the reason behind the banks’ particular downside lies in protectionism holding down long-term growth expectations, and the flattening of the yield curve,” reports CNBC.
The SPDR S&P Bank ETF (NYSEArca: KBE) and the SPDR S&P Regional Banking ETF (NYSEArca: KRE), the largest regional bank ETF, have also recently languished despite higher interest rates.
“Long-term growth expectations impact the ‘long end’ of the yield curve, referring to long-dated Treasury notes like the 10- and 30-year yields, which are not keeping pace with short-dated Treasury yields like that on the 2-year note,” according to CNBC. “While banks typically do well when interest rates rise, the reality is a steeper yield curve lends itself to greater profitability for the banks themselves.”
Related: Dodd-Frank Rollback Not a Credit Issue for Banks
Fortunately, the financial services sector 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. The financial sector valuations still look relatively cheap, compared to the broader market. The sector’s valuations are still about 25% below the average since the early 1990s.
For more information on the financial sector, visit our financial category.