This Bank ETF Is Looking Good

The financial services has been duly criticized this year for being a laggard in the face of still low interest rates, but the second-largest sector allocation in the S&P 500 has recently been improving. Over the past 90 days, the PowerShares KBW Bank Portfolio ETF KBWB is up 5.4 percent compared to a 2.1 percent gain for the S&P 500 over the same stretch.

Kickin' It With KBWB

KBWB tracks the widely followed KBW Nasdaq Bank Index. The Fed is almost universally viewed as one of the most determinants of performance for ETFs such as KBWB, but the central bank does not appear likely to oblige, as bonds markets are pricing in diminishing odds of even one rate hike before the end of this year. That deals a blow to a sector and its ETFs that came into 2016 with hopes of up to four rate hikes.

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Fed fund futures now say traders are paring bets that the Federal Reserve will raise interest rates later this month; but in August, inflows to financial services exchange-traded funds indicated otherwise. However, there are other catalysts for the likes of KBWB, including the recent separation of real estate from the financial services sector.

That transition, which will be completed later this week, means the richly valued real estate space departs the already attractively valued financial services group.

“Banks may look cheap relative to REITs right now, but a catalyst will likely be needed to reverse that trend. Higher interest rates would be one such catalyst. Predicting the direction of the 10-year Treasury yield is always difficult. However, the pace of economic growth, the direction of inflation and interest rates overseas may help investors interpret the interest rate landscape and outlook for the relative performance of bank shares to REITs,” said PowerShares in a recent note.

Holdings

KBWB's 24 holdings include familiar names such as Bank of America Corp. BAC, JPMorgan Chase & Co. JPM, Wells Fargo & Co. WFC and Citigroup Inc C. In other words, KBWB, unlike a real estate investment trust stock or ETF, would like to see interest rates move higher.

“Note that banks have generally outpaced REITs when interest rates are rising, and have tended to lag when interest rates are declining. This relationship can be most clearly seen after the Great Recession (early 2009). This pattern of relative performance may be linked to improved bank profitability in a high or rising interest rate environment and the desire of investors to own REITs for yield purposes in a falling or low rate environment. In a sense, REITs become a bond substitute,” according to PowerShares.

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