Was The Fed's Decision Really Bad For Financial Services ETFs?

It is no secret that financial services stocks and the corresponding exchange-traded funds are eager for the Federal Reserve to raise interest rates, something the central bank declined to do last week.

Investors' disdain for the Fed's continuation of its zero interest rate policy (ZIRP) as it pertains to ETFs such as the Select Sector Financial Slct Str SPDR Fd XLF was palpable. XLF, the largest financial services ETF by assets, slid nearly 2 percent last week. Rate-sensitive regional bank ETFs, including the SPDR KBW Regional Banking (ETF) KRE, fared worse. KRE, the largest regional bank ETF, slid 3.7 percent.

Financial Stocks Suffer Post-Central Bank's Announcement

“Financial stocks emerged as the whipping boy of the U.S. equity market Thursday, falling within minutes of the central bank’s post-meeting announcement. It continued Friday with the Standard & Poor’s 500 Financials Index slipping to a four-month low relative to the benchmark,” reported Anna-Louise Jackson for Bloomberg.

Related Link: Fed Reaction: Rate Uncertainty Unsettles Edgy Stock Market

XLF Highlighted

XLF tracks the S&P Financial Select Sector Index, which “includes companies from the following industries: diversified financial services; insurance; commercial banks; capital markets; real estate investment trusts (‘REITs’); thrift & mortgage finance; consumer finance; and real estate management & development,” according to State Street Global Advisors.

In what may be a surprise to many investors, it might actually be good news for ETFs like XLF that the Fed did not boost interest rates.

A Look Back

Earlier this month, Bank of America Merrill Lynch examined the sectors that perform well after Fed liftoff, those that disappointed and those that were somewhere in the middle. Bank of America used the prior six tightening cycles beginning March 1983, January 1987, March 1988, February 1994, June 1999 and June 2004.

For financial services investors betting on higher rates being a help, the results of the Bank of America Merrill Lynch study were surprising. In nine of the 12 months following Fed liftoff, financials were the worst or second-worst performing sector.

XLF's first full trading year was 1999; in 2000, after the Fed had begun hiking rates in June 1999, XLF was the best performing of the nine sector SPDRs. The financial services ETF gained 30.8 percent compared to an almost nine percent for the S&P 500, according to ETF Replay data.

During the Fed's most recent tightening cycle, 2004-2006, to its credit, XLF performed admirably. The ETF gained 40.2 percent, outpacing the S&P 500 by 470 basis points. However, that means XLF was only the fourth-best of the nine sector SPDR ETFs during that tightening cycle and that the financial services fund gained less than a third of what the Energy Select Sector SPDR (ETF) XLE did during the same period.

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