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How Financial ETFs Look After Fed Stress Test

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The U.S. Banking sector has cleared the key exam conducted by the Federal Reserve, barring a few. Regulators okayed most of the 35 largest U.S. banks to raise their dividends and buy back shares, reaffirming their ability to endure severe economic crisis.

In any case, the Fed’s support to shareholder value maximization has been strong from last year. In 2017, banks that cleared the stress tests were allowed to pay out 100% of their projected net income over the next four quarters, against 65% seen after 2016’s results.

Especially, in 2017, Citigroup received an approval of returning nearly 125% of projected earnings over the next four quarters. With this, J.P. Morgan announced its biggest share buyback since the financial crisis last year and Citigroup doubled its dividend (read: De-Stress Your Portfolio by Betting on Bank ETFs).

A Vortex of Dividend Hike Announcements

Soon after the Fed’s approval this year, the biggest U.S. banks announced plans to repurchase stocks and hike their quarterly dividends. Wells Fargo (WFC - Free Report) said it would more than double its stock buyback to $24.5 billion and hike its quarterly dividend to 43 cents a share from 39 cents. Citigroup (C - Free Report) would hike its quarterly dividend by 41% and buy back $17.6 billion of stock over the next year while J.P. Morgan Chase (JPM - Free Report) plans to increase its quarterly dividend to 80 cents from 56 cents a share and repurchase up to $20.7 billion in stock.

Shares naturally soared for these companies. However, Deutsche Bank DB failed to get the Fed’s nod to its proposal and Goldman Sachs (GS - Free Report) and Morgan Stanley (MS - Free Report) have been ordered to solidify their balance sheets by putting a cap on dividends and share buybacks.

Fed Policy Tightening: Another Tailwind

The operating backdrop has been positive for banks currently with the Fed having enacted two rate hikes this year, one in March and the other in June. The Fed is now planning a total of four rate hikes in 2018 citing steady economic growth, quite contrary to previous projections of a total of three increases this year. Since bank stocks perform better in a rising-rate environment, the Fed’s decision should go in their favor (read: Trade, Fed & Oil Wrote Top ETF Stories of 1H).

Market Reaction

The news boosted the financial sector on Jun 28 and helped the S&P 500 Financials index to snap its “13-day losing streak.” U.S. Financials iShares ETF (IYF) and S&P 500 Financials Sector SPDR (XLF - Free Report) gained about 0.9% each on Jun 28.

ETFs in Focus

Investors may be interested in investing in ETFs heavy on J.P. Morgan, Citigroup and Wells Fargo. These are iShares U.S. Financial Services ETF (IYG - Free Report) , XLF, Vanguard Financials ETF (VFH - Free Report) and Fidelity MSCI Financials Index ETF (FNCL - Free Report) . Citigroup and Wells Fargo have especial exposure to Invesco KBW Bank ETF (KBWB - Free Report) and Oppenheimer Financials Sector Revenue ETF (RWW - Free Report) . If anybody wants to stay away from Goldman and Morgan Stanley-rich funds, they should know that the duo has substantial weight in iShares US Broker-Dealers ETF (IAI - Free Report) .

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