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Financial ETFs at a 52-Week High: Further Rally Looks Likely

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Financial ETFs have rebounded this year after a prolonged period of volatility and are currently trading at a 52-week high. A flattening yield curve played spoilsport in the past two years.However, the vaccine drive, the return of global growth and the resultant inflationary pressure, rising oil demand and consumers’ savings on fiscal and monetary stimulus have made the space a winner this year.

Financial Select Sector SPDR Fund (XLF - Free Report) is up 35.4% this year versus 19.1% in the S&P 500. Several financial ETFs are trading at a 52-week high currently. We expect more room to run for the space. Let’s find out what’s working in favor of financial ETFs now.

Gradually Steepening Yield Curve

Since banks borrow money at short-term rates and lend capital at long-term rates, the steepening of the yield curve is always a plus for bank ETFs. On Oct 19, the spread between the 10-year and two-year treasury yield stood at 124 percentage points versus 82 percentage points recorded at the start of the year, benefitting bank stocks and ETFs.

Notably, the movement of short-term bonds is more dependent on Fed behavior than long-term bonds. The benchmark 10-year treasury yield rose to a 5-month high as Federal Reserve Gov. Christopher Waller said tapering should start in November. With rates likely to remain at the rock-bottom level in the near term and QE taper likely to hit the market due to rising inflationary pressure, a steepening yield curve is likely.  

Meanwhile, the upcoming holiday season and several sales-boosting events should boost risk-on sentiments, contributing to the rise in long-term bond yields in the upcoming weeks.

Favorable Earnings Picture

Per the Earnings Trends issued on Oct 13, 2021, earnings from the financial sector are projected to jump 24.7% on 4.9% higher revenues in Q3, which follows 147.0% earnings growth on 10.9% higher revenues in Q2 of 2021. The strong Q2 growth was primarily a function of easy comparisons, as the year-earlier profitability was held down by loan-loss reserves as the pandemic got underway. Big banks have come up with upbeat earnings this reporting season (read: Banking Earnings Upbeat: Time to Buy Financial ETFs on Value?).

Focus on Value

Financial stocks are undervalued at the current level. The financial sector’s Investment Bank and Major Regional Bank segment currently have a P/E of 12.20X and 11.79X, respectively. Both are lower than the P/E of 20.74X boasted by the S&P 500 ETF iShares Core S&P 500 ETF (IVV - Free Report) . The sector also has a less debt burden with a Debt-to-Equity ratio of 0.33X and 0.63X, respectively, for the above-mentioned space. These are down from the 0.64X debt-to-equity ratio boasted by the S&P 500.

ETFs in Focus

Against this backdrop, we highlight a few financial ETFs that are currently on a one-year high and are poised for more rally.

US Financials iShares ETF (IYF - Free Report) – Up 32.0%

Financial Alphadex ETF First Trust (FXO - Free Report) – Up 37.9%

S&P 500 Equal Weight Financials Invesco ETF (RYF - Free Report) – Up 35%

U.S. Regional Banks iShares ETF (IAT - Free Report) – Up 40.8%

S&P 500 Financials Sector SPDR (XLF - Free Report) – Up 35.4%