What's Really Weighing On Financial Services ETFs

It wasn't supposed to be this way for financial services exchange-traded funds. The Federal Reserve raised interest rates last month, doing so for the first time in nearly a decade, and market observers widely expect a couple of more rate hikes this year.

Conventional wisdom dictates higher interest rates are usually a good thing for bank stocks, but that has been far from true in 2016, with rate-sensitive regional bank stocks and ETFs being among the New Year's most disappointing performers.

Feeling The Pain

That is even more disappointing for the broad swath of money managers that made financial services, the S&P 500's second-largest sector weight, the most allocated to sector in December.

Those money managers and their clients are feeling some pain, because less than a month into 2016, the Financial Select Sector SPDR (Select Sector Financial Slct Str SPDR Fd XLF), the largest financial services ETF, is the second worst performer among the nine legacy sector SPDRs with an 11 percent loss. Even the moribund Energy Select Sector SPDR (ETF) XLE has outpaced XLF to start the year.

Related Link: Bank On Dividends With Bank ETFs

Investors' dissatisfaction with bank ETFs is on full display with XLF, which has bled $1 billion in assets this year. Only six other ETFs have lost more assets since the start of the year.

What Is Really Causing Investor Reactions?

Against such an ominous backdrop, identifying the catalysts behind the financial sector's woes is a worthy endeavor, one that shows answers beyond the Fed and slumping oil prices.

“Take a look at the ratio of the Financial Select Sector SPDR Fund relative to the SPDR S&P 500 ETF Trust (XLF/SPY),” said Rareview Macro founder Neil Azous in a note out Tuesday.

“As you can see, over the last 10 years the 14-day relative strength index (RSI) has never been this oversold, including during the Global Financial Crisis.”

As Azous pointed out, the book values of some of XLF's marquee constituents reside nowhere near the nadirs seen in 2011 when global investors were fretting over Greece possibly departing the eurozone— meaning there is more to the financial services sector's current malaise. Several ominous points underscore the weakness seen in financial services stocks and ETFs to start 2016.

“The selling is about asset deterioration and banks beginning to price in the jump to a 40 percent from 20 percent probability of a recession,” said Azous. “The selling is beginning to include concerns over the consumer – that is, peak autos and a pause in the housing recovery.”

Disclosure: Todd Shriber owns shares of XLF.