Time to Buy Financial & Bank ETFs?
Financial exchange-traded funds (ETFs) have rebounded this year after a prolonged period of volatility. A flattening yield curve was a major concern over the past few years. However, decent global growth, cooling U.S. inflation and hopes of a Fed rate cut have now made the space a winner.
Shares of Financial Select Sector SPDR Fund XLF are up 17.7% this year versus an 18.9% gain for the S&P 500. We expect the space to have more room to run. Let’s find out what’s working in favor of financial ETFs now.
Gradually Steepening Yield Curve
Since banks borrow money at short-term rates and lend capital at long-term rates, the steepening of the yield curve is always a plus for bank ETFs. On Friday, the spread between the 10-year and two-year treasury yield stood at negative 0.09 percentage points versus negative 0.17 percentage points recorded at the start of the month, benefiting bank stocks and ETFs.
Notably, the movement of short-term bonds is more dependent on Fed behavior than long-term bonds. With the Fed likely to enact its first rate cut in four years in September, short-term rates are likely to fall ahead. This would boost risk-on trade sentiments and increase long-term rates, which is why a steepening yield curve is likely.
Focus on Value in Financial Sector
Financial stocks are undervalued at the current level. The financial sector’s Major Regional Bank segment currently has a forward P/E of 12.14X. This is lower than the P/E of 19.46X boasted by the S&P 500 ETF iShares Core S&P 500 ETF IVV. The dividend yield of the Major Regional Bank segment is 3.32% versus 1.55% possessed by the S&P 500.
Favorable Earnings Picture for Banking Giants
Leading banks such as Goldman Sachs GS and JPMorgan Chase JPM reported robust increases in investment-banking revenues in the second quarter of 2024.
The revival was backed by improved economic conditions that prompted corporate clients to engage in deal advisory and debt offerings. Executives are cautiously optimistic, viewing these developments as early signs of recovery in capital markets and mergers and acquisitions, according to the Wall Street Journal (read: What You Need to Know About Bank ETFs In Light of Q2 Earnings).
The earnings report also indicated challenges in consumer banking segments. Higher inflation and interest rates exerted pressure on lower-income consumers. If rate cuts continue to be implemented, this segment should fare better.
Financials ETFs in Focus
Against this backdrop, we highlight a few financial ETFs that are poised for further rally.
US Financials iShares ETF IYF – Shares up 19.6% this year.
Financial Alphadex ETF First Trust FXO – Shares up 16.6% this year.
U.S. Regional Banks iShares ETF IAT – Shares up 13.2% this year.
S&P 500 Financials Sector SPDR XLF – Shares up 17.7% this year.
Invesco KBW Bank ETF KBWB – Shares up 17.7% this year.
Is There Any Wall of Worry?
Although things are improving for the U.S. financial sector, investors should not forget the U.S. regional banking crisis in March 2023. Some pressure may still be felt in the regional banking space. SPDR S&P Regional Banking ETF KRE has gone up 9.8% this year.
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The Goldman Sachs Group, Inc. (GS) : Free Stock Analysis Report
JPMorgan Chase & Co. (JPM) : Free Stock Analysis Report
Financial Select Sector SPDR ETF (XLF): ETF Research Reports
SPDR S&P Regional Banking ETF (KRE): ETF Research Reports
Invesco KBW Bank ETF (KBWB): ETF Research Reports
iShares U.S. Regional Banks ETF (IAT): ETF Research Reports
First Trust Financials AlphaDEX ETF (FXO): ETF Research Reports
iShares U.S. Financials ETF (IYF): ETF Research Reports