Are Broker-Dealer ETFs Breaking Out?

A breakout in some of the largest financial companies in the US could be an indication of things to come for the overall stock market.

The NYSE Broker-Dealer Index recently rallied to a six-year high led by the big players, and is up more than two percentage points over the past week. While the overall stock market has been hitting new highs on a consistent basis, the broker-dealers have been lagging until the recent move.

The market, generally speaking, is experiencing sector rotation as money flows from other sectors that have been deemed as overvalued into lagging sectors. The broker-dealers typically lead a market rally, and with the space now breaking out, it could be the start of yet another big rally for all stocks.

Investors Were Weary Of Broker-Dealers

For years, investors were weary of investing in broker-dealers for several reasons.

Negative sentiment, on large financials in particular, has been an issue in the past, specifically during the most recent recession. While there may be some validity to that notion, the blame can -- and should -- be spread much further.

Another factor keeping investors away from the sector has been increased regulation by the government. The thought is: More regulation equals higher costs for companies, which can hurt profitability and ultimately stock valuations.

Finally, it appears many continue to struggle to understand the business model that many of the large broker-dealers implement.

While all three are good enough reasons to keep the sector out of a portfolio, in reality investors are only hurting themselves. The recent breakout should be a green flag inviting investors back into the sector.

Related Link: Consumer Staple ETFs Hitting Highs

A Trading Idea

One potential broker-dealer trading idea is through the iShares U.S. Broker-Dealers ETF IAI.

The ETF is a basket of US investment banks, discount brokerages, and stock exchanges. The portfolio is comprised of 22 publicly traded companies in the investment services industry. Its top investments include Goldman Sachs Inc. GS with a 9.7 percent holding, Morgan Stanley MS at 8.6 percent, and Charles Schwab Corp SCHW at 7.9 percent.

IAI has struggled in the last 12 months, underperforming the market (up five percent compared to the 17 percent gain in the SPDR 500 S&P Trust Series ETF SPY  over that time).

On the other hand, choosing an ETF instead of an individual stock allows investors to nearly eliminate company-specific risk.

Disclosure: At the time of this writing, the author had no position in the equities mentioned in this report.