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Should You Buy Bank ETFs on the Dip?

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The financial sector, which accounts for around one-fifth of the S&P 500 index, is now into the Q4 earnings reporting cycle. The trend has been favorable so far with three major banks crushing estimates on both lines while three others reporting mixed results.

The Zacks Sector Rank for banks is in the top 6%, with several banking bellwethers sporting a Buy rating (either Zacks Rank #1 (Strong Buy) or #2 (Buy)). The backdrop seems to be in favor of the banks including the course of oil, the stance of the Fed and policies of Trump.

Big Bank Earnings in Focus

JP Morgan JPM reported earnings of $1.71 per share beating the Zacks Consensus Estimate of $1.42. Also, the figure reflects a 30% rise from the year-ago period. Managed net revenue of $24.3 billion in the quarter was up 2% from the year-ago quarter and beat the Zacks Consensus Estimate of $23.1 billion.

Wells Fargo WFC earned $1.03/share in Q4, beating the Zacks Consensus Estimate by $0.03. Moreover, it compared favorably with the prior-year quarter’s earnings of $1.00 per share. The quarter’s total revenue of $21.6 billion lagged the Zacks Consensus Estimate of $22.4 billion. Revenues were in line on a year-over-year basis.

Citigroup Inc.’s (C - Free Report) earnings from continuing operations per share of $1.14 for Q4 were ahead of the Zacks Consensus Estimate of $1.12. Earnings compared favorably with the year-ago figure of $1.03 per share. Adjusted revenues however declined 9% year over year to $17.07 billion but came below the Zacks Consensus Estimate of $17.05 billion.

Bank of America Corporation’s BAC fourth-quarter 2016 earnings of $0.40 per share surpassed the Zacks Consensus Estimate of $0.38. Also, the figure was 48% higher than the prior-year quarter number. Net revenue came in $20.2 billion, up 2% from the prior-year quarter and fell below the Zacks Consensus Estimate of $20.6 billion.

Goldman GS earned $5.08 per share in Q4, beating the Zacks Consensus Estimate of $4.76. Net revenue of $8.17 billion surpassed the Zacks Consensus Estimate of $7.43 billion. The bank’s trading unit registered a 25% uptick in revenues, driven by a 78% rise in activity at its fixed income, currency and commodities trading division.

Morgan Stanley’s MS fourth-quarter 2016 earnings from continuing operations of $0.81 per share crushed the Zacks Consensus Estimate of $0.65. Further, earnings skyrocketed 88% year over year, excluding DVA adjustments. Net revenue amounted to $9.0 billion, reflecting an increase of 17% from the prior-year quarter. It also surpassed the Zacks Consensus Estimate of $8.5 billion. Bond trading revenues were solid in the quarter.

Market Impact

Investors, who have pinned their hopes on an assuring earnings season and favorable fundamentals, must be keen to know the performance of financial ETFs like iShares U.S. Financial Services ETF IYGiShares US Financials ETF IYFPowerShares KBW Bank ETF KBWBFinancial Select Sector SPDR XLF and Vanguard Financials ETF VFH. These funds have considerable exposure to the aforementioned stocks (see all Financial ETFs here).

But despite the decent earnings, all these ETFs slipped in the last five days (as of January 19, 2017).

Why Such a Drop?

Banking stocks staged an astral rally post Trump’s win. Hopes of easing relations, increased inflationary expectations, which translated into higher treasury yields, and the Fed policy tightening benefited the sector. In the last three months (as of January 19, 2017), XLF gained about 18.8% while KBWB advanced 25.9%  (read: Time to Prepare for 'Trump Slump' with These ETFs?)

Against such a backdrop, profit booking, a diminishing Trump rally and lack of clarity about Trump’s policy layouts in his first press conference caused the latest selloff (read: Trump's First Press Conference Puts These ETFs in Focus).

Will the Tables Turn?

The rising rate prospects in the U.S. and chances of a rebound in oil prices on the OPEC output cut deal may prove to be favorable for these stocks and ETFs. This is because U.S. banks have significant exposure to the long-beleaguered energy sector. But lately, with the oil price recovery, tension over credit default seems to be diminishing while prospects of M&A and refinancing activity will increase.

We all know that financial stocks perform better in a rising rate scenario. With the economy gaining traction and the Fed looking to enact three rate hikes this year, banking ETFs are likely to see a great year ahead.

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