A Neutral View On A Big Financial ETF

The Financial Select Sector SPDR Fund XLF, widely viewed as one of this year's most disappointing sector exchange-traded funds, has recently shown signs of momentum. Over the past week, XLF, the largest ETF dedicated to the financial services sector, is higher by 4.2 percent. That could bode for XLF as it enters what is historically a good time of year to be long bank stocks.

Additionally, there have been signs, though incremental, of bullish options activity in XLF.

“Likewise, but in smaller size, we have also seen some near term July 24.50 call buyers in XLF, and we remind readers that the fund traded as high as $24.60 just seven trading sessions ago. The fund eclipsed $25 before reversing sharply back in early March,” said Street One Financial Vice President Paul Weisbruch in a note out last week.

Needs Some Convincing

Some analysts need to see more from XLF before turning bullish on the ETF. For example, AltaVista Research tagged XLF with a Neutral rating in a note out Monday. That rating “indicates that valuations adequately reflect the fundamentals of stocks in these funds. The majority of funds we cover fall into this category,” said the research firm.

With the assistance of the aforementioned 4.2-percent gain over the past week, XLF is higher by 7.7 percent year to date. While that still trails the S&P 500, XLF is finally cobbling together some upside following two interest rate hikes by the Federal Reserve. Financial stocks, which are usually positively correlated to rising interest rates, could finally be responding to that theme and could also be telling investors that another Fed rate hike before 2017 ends is a foregone conclusion.

Recent results from the Comprehensive Capital Adequacy Review and the Dodd-Frank Stress Test are also helping the stocks found in XLF and rival bank ETFs. The good news for investors is that the Fed does not objective to most of the capital payout plans set forth by big banks, meaning more share buybacks and higher dividends could be on the way for XLF member firms.

Rising Multiples, But Still Attractive

The financial services sector's earnings multiples have started inching higher, but the sector is still one of a small amount that is a credible value play against the broader market. Additionally, the group trades at a discount to long-term averages.

“Financials remain the best performing sector since the election (though momentum slowed in 1H17), reflecting investors' hopes for higher interest rates and repeal of regulations like Dodd-Frank,” added AltaVista. “Expectations remain high: consensus forecasts show considerable improvement in ROE and margins in 2017-18E. The sector's P/E is back at the high end of its range in recent years, yet Financials still look attractive vs the S&P 500.”

Disclosure: Todd Shriber owns shares of XLF.

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