Bank On This Bank ETF

Bank stocks and the related exchange traded funds are vexing investors this year. The SPDR S&P Bank ETF KBE, for example, is up 4.2 percent year-to-date while the S&P 500 is higher by almost 7 percent.

The laggard status of the financial services sectors comes against the backdrop of two interest rate hikes by the Federal Reserve and expectations for more rate increases before the end of 2018. Entering this year, Fed tightening was a widely cited factor by market observers speculating on more upside for bank stocks.

What To Know

“Concerns over a flattening yield curve have pressured financial stocks. While these stocks struggle, there is one segment within the sector that investors may want to consider: bank stocks,” said State Street Global Advisors (SSgA) in a recent note.

Broader financial services ETFs feature exposure to broker dealers and insurance providers in addition to traditional banks. For its part, the $3.81 billion KBE is almost entirely devoted to banks with small exposure to asset managers. Regional banks, which are usually positively correlated to rising intererest rates, represent 77 percent of KBE's roster.

Why It's Important

The Fed is expected to boost borrowing costs to 2.25 percent from 2 percent at its September meeting and to 2.50 percent from 2.25 percent at its December meeting.

“Despite a flattening yield curve, net interest margins continue to expand, which is a positive sign for banks’ corporate profits,” said SSgA. “While banks’ interest expense—the interest rates banks must pay on deposits—remain near zero, the interest rates that banks earn on their commercial and personal loans have increased as the Federal Reserve raises rates, boosting banks’ interest income.”

What's Next

As has been noted, accelerating domestic economic growth is an important catalyst for the financial services sector, particularly the group's smaller members. KBE's 80 holdings are equally weighted, meaning the fund is not dependent on large- and mega-cap names to drive its performance.

“As the economy has continued to post solid growth and tax law changes are providing a further boost to the economy, loan growth has accelerated—topping out at 6.5% in July,” said SSgA.

Investors have pulled $128.48 million from KBE this year, but the fund has seen third-quarter inflows of $16.75 million.

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