The U.S. stock market is showing strong complacency amid trade fears, with the S&P 500 and Dow Jones hitting new highs. While most of the sectors have been rallying, a few are lagging behind and financials is one of them. However, this seems to be the right time to get into this sector stocks and ETFs.
Below, we have highlighted some strong reasons for the outperformance of the broader sector: Rising Rates Rates have been on the rise this year with 10-year Treasury yields hovering above 3% and 2-year yields near a decade high of 2.8%. The upward trend is likely to continue given that the escalating tit-for-tat tariff trade will result in higher consumer price for products, stoking inflation. Trump has imposed the second round of tariffs of 10% on $200 billion worth of Chinese goods starting Sep 24. The taxes will be increased to 25% effective Jan 1. In retaliation, China slapped a tariff of 10% on more than 5,000 American products worth $60 billion. Trump’s new tariff will be in addition to $50 billion that is already in place with a 25% duty. China has retaliated with tariffs of equivalent amount of U.S. exports. Apart from this, Trump also threatened a third round of tariffs on another $267 billion of Chinese imports on a short notice, which would mean levying duties on nearly everything China exports to the United States. Additionally, the Fed has raised interest rates twice this year and is expected to make a third-rate hike as soon as next week. One more hike is expected in December. According to the CME Group's FedWatch tool, market expectations for a rate hike this month are more than 90% (read: September Rate Hike Odds Rise: Top Sector ETF & Stock Picks). A rising interest rate scenario is highly profitable for the financial sector as it will expand profits of banks, insurance companies, discount brokerage firms and asset managers. VIDEO Trump Action Trump has rolled back some financial regulations, dismantling the Dodd-Frank Act, which was enacted in the aftermath of the financial crisis and has crimped some of the business lines of the banks. Easing of regulations will undoubtedly increase profitability of the companies, particularly banks, and boost dividends and buybacks (read: Regional Bank ETFs & Stocks to Party on Dodd-Frank Easing). Encouraging Fundamentals The combination of some other factors also bodes well for the financial sector. Accelerating economic growth, strengthening job market, growing consumer confidence and healing housing market may lead to higher demand for loans and all types of financial services. Further, higher oil prices are acting as catalysts given that most banks are highly exposed to the energy sector. Impressive Earnings Per the latest Earnings Trends, financial earnings showed impressive growth of 21.3% in the second quarter and are expected to grow 33.1% in the third quarter, representing the fourth largest contribution to S&P 500 earnings (see: all the Financial ETFs here). Valuation The Financial sector has been underperforming the market this year, having lost 0.3% so far. The beaten down prices have made its valuation appealing to investors as the sector is currently trading at P/E of 13.83 versus that of 18.28 for the S&P 500 Composite Index. Beta is also low at 0.62 compared with 0.99 for the S&P 500. All these metrics suggest that the sector has room for upside in the coming months. Top ETFs to Consider In view of the reasons discussed above, we strongly believe that investors should consider financial ETFs. We have highlighted six ETFs with the top Zacks Rank #1 (Strong Buy) or #2 (Buy). Financial Select Sector SPDR Fund ( XLF - Free Report) This is by far the most popular financial ETF in the space with AUM of $31.9 billion and average daily volume of nearly 53.7 million shares. The fund follows the Financial Select Sector Index, holding 67 stocks in its basket. It is heavily concentrated on the top two firms that collectively make up for 24% of the portfolio while other firms hold no more than 8.5% share. In terms of industrial exposure, banks take the top spot at 44.5% while capital markets, insurance, and diversified financial services make up for double-digit exposure each. The fund charges 13 bps in annual fees and is up 4.6% in the year-to-date timeframe. It has a Zacks ETF Rank #2 with a Medium risk outlook. SPDR S&P Regional Banking ETF ( KRE - Free Report) This fund targets the regional banking corner of the financial sector and follows the S&P Regional Banks Select Industry Index. It holds 124 stocks in its basket with none accounting for more than 1.94% of the assets. KRE is one of the largest and the most popular ETFs in the banking space with AUM of $5.1 billion and average daily volume of around 5.6 million shares. It charges 35 bps a year in fees and has added 7.6% so far this year. The product has a Zacks ETF Rank #1 with a High risk outlook. SPDR S&P Bank ETF ( KBE - Free Report) This fund offers equal-weight exposure to 80 banking stocks by tracking the S&P Banks Select Industry Index. Regional banks dominate the portfolio with 76.7% share while thrifts & mortgage finance, diversified banks, asset management & custody banks and other diversified financial services take the remainder. It has amassed $3.6 billion in its asset base and carries a Zacks ETF Rank #2 with a High risk outlook (read: Top-Ranked Bank ETFs & Stocks Set to Explode Higher). iShares U.S. Broker-Dealers & Securities Exchanges ETF ( IAI - Free Report) This fund offers exposure to the U.S. investment banks, discount brokerages, and stock exchange firms by tracking the Dow Jones U.S. Select Investment Services Index. The product currently holds 27 securities with the largest allocation going to top five firms that collectively account for 45.8% of the portfolio. It has accumulated $328.5 million in AUM and trades in moderate volume of nearly 78,000 shares a day. The product charges 43 bps in fees per year from investors and has gained 4.8% in the year-to-date timeframe. It has a Zacks ETF Rank #2 with a High risk outlook. S&P Financials Revenue ETF ( RWW - Free Report) This ETF offers investors targeted access to the same stocks as the S&P 500 Financials Index but weighs each security by revenues instead of market capitalization. It holds 69 stocks in its basket with higher concentration on the top firm at 16.4% while other firms make up for less than 8% of the assets. The product failed to garner immense investors’ attention as depicted by its AUM of $59.5 million and average daily volume of 3,000 shares. It has 0.45% in expense ratio and has added 2.9% so far this year. The fund has a Zacks ETF Rank #2 with a Medium risk outlook (read: