The U.S. financial sector, which accounts for around one-fifth of the S&P 500 index, has been on an uptrend. Strong loan growth, improving credit quality, decent M&A and IPO activities, as well as stable balance sheets are fueling optimism in the broad sector.
U.S. President-elect Donald Trump’s unexpected victory over Clinton acted as a major tailwind for banking stocks in the latter part of 2016. Hopes of higher inflationary expectations thanks to Trump’s pro-growth policy plans resulted in higher U.S. Treasury yields, which in turn facilitated banking stocks that benefit in a rising rate environment. Expectations of easing regulations in the Trump era also boosted financial stocks in recent times.
The Fed enacted key rate hikes four times after almost a decade since December 2015, with the latest being in June 2017. In June, the Fed raised the target range for its federal funds rate by 25 bps to 1—1.25%. The Fed is likely to enact more hikes this year.
However, though the Fed remained on the policy tightening mode, U.S. Treasury yields remained subdued on political concerns and some downbeat U.S. economic data. This kept bank ETFs from soaring higher.
However, while lower levels of yields are concerns, there are several factors that are in for a bank ETF rally. Below we highlight those.
Shareholder Value Maximization
The Fed approved plans from the 34 largest U.S. banks to deploy additional capital in stock buybacks, dividends and other purposes for the first time since the financial crisis (read: De-Stress Your Portfolio by Betting on Bank ETFs).
Citigroup (C) has received an approval of returning nearly 125% of projected earnings over the next four quarters. As per Goldman Sachs, the 23 banks subject to CCAR stress tests conducted by the Federal Reserve will return 43% more capital to investors in 2017 than in 2016.
Increasing Net Interest Rate Margin
The “prime rate”, which measures the prices of loans such as credit cards, has risen from 3.5% a year ago to 4.25%. Interest on depositors remains low (average rate on savings accounts is 0.08%), resulting in wider interest spread. As result, there was an improvement in the net interest rate margin in recent times. Barclays expected that net interest margin (NIM) would rise between 3 and 6 basis points in the second quarter, as per an article published on Financial Times, after an 8-bp rise in the first quarter.
Recoiling IPO Market
After a subdued 2016, the U.S. IPO market vaulted to start 2017. About 25 IPOs fetched about $10 billion in the first quarter and 52 companies that completed their IPOs in the second quarter raised nearly $11 billion.
The second quarter marked the most active one in two years as per IPO research intelligence Renaissance Capital. This is in stark contrast to the start of 2016, with 1H16 being the worst first half of any year since 2009 in terms of the number of companies going public.
As per the source, 2017 is likely to see “the first annual increase in IPOs in four years.” Since IPO activities require the involvement of several U.S. banks as advisors, the heating IPO market is likely to help these banks increase their equity underwriting market share.
As per the Earnings Trends issued on August 16, 2017, 100% of the financial sector’s total market cap are out with results. Total earnings are up 7.2% from the same period last year in Q2 of 2017 on 3.9% higher revenues. As much as 76.3% companies beat EPS estimates and 68% beat on the top line. Banks-Major recorded earnings growth of 10% while Banks & Thrifts registered earnings increase of 32.8% (read: How Banking ETFs Are Behaving Post Earnings).
Financial Choice Act if Approved
The Financial Choice Act (FCA) has already been passed by the U.S. House of Representatives in June 2017, though it will go through modifications before finalization. FCA is aimed at reviewing the Dodd-Frank Act and delaying in implementing the fiduciary rule. Notably, these rules hurt banks’ profitability and raised regulatory costs over the years.
The fiduciary rule requires advisors to act in the best interest of their clients. So, any change in it would be a tailwind to banking companies, and especially the asset management divisions. However, with Health Care bill failing to see the light of the day, uncertainty is looming large on the materialization of the Financial Choice Act.
ETFs in Focus
So, investors with a long-term outlook, may tap bank ETFs like SPDR S&P Bank ETF (KBE - Free Report) , SPDR S&P Regional Banking ETF (KRE - Free Report) , PowerShares KBW Regional Banking Portfolio ETF (KBWR - Free Report) and PowerShares KBW Bank Portfolio ETF (KBWB - Free Report) . Regional banks are lagging this year due to lower bond yields but may spring higher if rates rise on the Fed’s policy tightening (read: ETF Strategies to Win if Fed's Reverse QE Hits Soon).
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