Financial sector has been on a stellar ride this year having gained 5.6% thanks to the dual tailwinds of the Fed’s rate policy and Trump presidency. Improving economic fundamentals and industry trends added to the strength though some analysts are concerned about higher valuations.
Below we discuss some strong reasons for investing in financial ETFs now.
Fed Policy
The Fed is likely to raise interest rates by 25 bps to 0.75–1% from 0.50–0.75% later today in its latest monetary policy decision. Per the latest CME Group poll, the odds for a rate hike shot up to 93% from just 25% in the beginning of February. This would represent the third rate hike in 10 years. Upbeat February job data and rising inflation, which is heading toward the 2% target, have bolstered the case for lift-offs in the current ongoing meeting. These also signal a faster pace of increase this year.
A rising interest rate scenario is highly profitable for the financial sector as the steepening yield curve would bolster profits for banks, insurance companies, discount brokerage firms and asset managers.
Trump Action
Trump is in process of rolling back some financial regulations. He seeks to dismantle the Dodd-Frank Act, which was enacted in the aftermath of the financial crisis and has crimped some of the business lines of the banks. The other is to repeal the fiduciary rule slated for April, aimed at financial advisors who are supposed to act in the best interest of their clients when providing retirement advice rather than seeking higher commissions for themselves.
Relaxing of regulations will undoubtedly increase profitability of the companies, particularly banks, and boost dividends and buybacks.
Encouraging Fundamentals
The combination of other factors is also leading to higher prices for financial stocks. Accelerating economic growth, strengthening job market, growing consumer confidence and solid housing market may lead to higher demand for loans and all types of financial services. Further, stabilizing oil prices are acting as catalysts given that most banks are highly exposed to the energy sector.
Solid Zacks Rank
The upside to the finance sector is confirmed by the Zacks Sector Rank in the top 31% with about 64% of the industries having ranking in the top 40%. This suggests continued outperformance in the sector for the coming months. That said, Banks – Northeast topped the list followed by Financial – Investment Bank and Banks – Midwest.
Impressive Earnings
Per the latest Earnings Preview, financial earnings have shown impressive growth of 16.6% in the fourth quarter, being the second largest contributor to earnings growth for the S&P 500. The trend is likely to continue into the first quarter 2017 with expected earnings growth of 5.4% representing the third-highest growth.
Valuation
Currently, the financial sector is reasonably valued with P/E ratio of 15.37 versus 18.61 for the S&P 500. Beta is also low at 0.74 compared with 1.01 for the S&P 500. All these metrics suggest that the sector has room for upside in the coming months.
Top ETFs to Consider
In view of the reasons discussed above, we strongly believe that investors should consider financial ETFs. We have highlighted six ETFs having the top Zacks Rank of 1 or ‘Strong Buy’ rating:
SPDR S&P Regional Banking ETF (KRE – Free Report)
This fund targets the banking corner of the financial sector and follows the S&P Regional Banks Select Industry Index. It holds 101 stocks in its basket with none holding more than 3.84% of assets. KRE is one of the largest and the most popular ETFs in the banking space with AUM of $4.3 billion and average daily volume of more than 7 million shares. It charges 35 bps a year in fees and has added 2.4% so far this year.
First Trust NASDAQ ABA Community Bank Index Fund (QABA – Free Report)
This ETF offers exposure to banks and thrifts, and tracks the NASDAQ OMX ABA Community Bank Index, holding 160 stocks in its basket. It is well spread out across various components as none accounts for more than 3.37% of assets. The fund has accumulated $486.2 million in its asset base and trades in volume of around 95,000 shares a day on average. It charges 60 bps in annual fees and has shed 1.7% since the start of the year.
iShares U.S. Broker-Dealers & Securities Exchanges ETF (IAI – Free Report)
This fund offers exposure to the U.S. investment banks, discount brokerages, and stock exchange firms by tracking the Dow Jones U.S. Select Investment Services Index. The product currently holds 26 securities with the largest allocation going to top five firms that collectively account for 44.8% of the portfolio. It has accumulated $251.1 million in AUM and trades in moderate volume of nearly 62,000 shares a day. The product charges 44 bps in fees per year from investors and has gained 7% in the year-to-date timeframe.
Financial Select Sector SPDR Fund (XLF – Free Report)
This is by far the most popular financial ETF in the space with AUM of $25.4 billion and average daily volume of nearly 69.2 million shares. The fund follows the Financial Select Sector Index, holding 64 stocks in its basket. It is heavily concentrated on the top five firms that collectively make up for 44.6% of the portfolio while other firms hold no more than 3% share. In terms of industrial exposure, banks take the top spot at 45.5% while capital markets, insurance, REITs and diversified financial services make up for double-digit exposure each. The fund charges 14 bps in annual fees and is up 6.6% in the year-to-date timeframe.
