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3 Reasons to Be Wary of Bank ETFs

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Banks were hit hard at the peak of the COVID-19 pandemic due to the likelihood of higher default rates on loans as well as rock-bottom interest rates. However, easing social-distancing restrictions, the gradual return of risk-on sentiments, and the Fed and the government’s caretaking of the liquidity position of corporates and households through unprecedented stimulus measures helped boost investors’ confidence on bank shares temporarily.

SPDR S&P Bank ETF (KBE - Free Report) is down 9.4% in the past month, has lost 13.3% in the past three months and is off 40.4% this year. Against this backdrop, we highlight a few reasons that may continue to hurt bank shares in the coming days as well (read: Bank ETFs Struggling on Mixed Earnings & Coronavirus-Hit Views).

Chances of Rising Virus Cases in Winter

The U.S. economy may have to deal with more foreclosures and business bankruptcies in the fall and winter if there is a rise in infections, further lockdowns and no additional fiscal aid, per Boston Federal Reserve President Eric Rosengren, as quoted on a Reuters article.

Community and regional banks could especially be more vulnerable if there is a rise in delinquencies in commercial real estate loans as businesses are facing pressure, indicated Rosengren. Some businesses that borrowed in the corporate bond market before the crisis are likely to face difficulty in paying off the debt, per the Boston Fed president.

The above-said remarks indicate that ETFs like SPDR S&P Regional Banking ETF (KRE - Free Report) and First Trust NASDAQ ABA Community Bank Index Fund (QABA - Free Report) could be, particularly, under more stress.

Biden’s Considerable Chances of Winning Election

Banks were a key beneficiary in the lower-tax environment. Big U.S. banks have enjoyed an average 13% increase in earnings per share from the lower rate, per Goldman Sachs. Banks also enjoyed easing of regulatory stringencies in recent years.

However, under Biden's plan of tax hike, 10 largest U.S. banks may see their combined annual net income decline by more than $7 billion, according to an S&P Global Market Intelligence analysis. However, many banks have significant deferred tax assets, per the above-mentioned analysis. The impact of higher income taxes will make deferred tax assets more valuable and favor tangible book values – a coveted metric investors are currently looking at, per the article. So, even if bank shares cross the hurdle in the short term, long-term earnings pressure is a concern.

Low Rates for Longer

More economic weakness means low inflation and rates for a long period of time.U.S. interest rates have been at record-low levels since March 2020. The central bank said that it will continue to purchase $120 billion in government bonds each month. The Fed will keep interest rates at zero at least through 2023.

In the Fed’s latest projections, core inflation is expected to stay low and not reach the Fed’s 2% target until 2023. The labor market is expected to improve to the point where unemployment is likely to be at 4% in 2023, falling short of the longer run rate of 4.1% (read: No Rate Hike Until 2023: Here's How to Play With ETFs).

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