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Big Banks Clear Fed's Stress Test, ETFs Rally

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U.S. banking biggies have cleared the key Stress Test conducted by the Federal Reserve, barring the U.S. division of Credit Suisse. Regulators allowed a majority of the 18 institutions to raise dividends and buy back shares.

However, Credit Suisse has a weak capital planning process, according to the Fed. JPMorgan Chase and Capital One struggled a bit with both required to adjust their capital plans in order to conform to the central bank's minimum criteria. The go-ahead was especially big for Deutsche Bank AG as it had been unsuccessful in the past tests. The test reaffirms big banks’ ability to endure severe economic crisis.

A Vortex of Dividend Hike Announcements

Goldman Sachs GS boosted its quarterly dividend by nearly 50% to $1.25 a share from 85 cents, and authorized a $7-billion stock repurchase program, up from $5 billion a year ago.

J.P. Morgan Chase JPM raised its dividend to 90 cents a share from 80 cents. The bank might also buy back up to $29.4 billion worth of stocks under a new program, compared with $20.7 billion last year.

Bank of America BAC announced a dividend hike to 18 cents a share from 15 cents and can repurchase up to $30.9 billion in stocks. Wells Fargo WFC lifted its dividend payout to 51 cents a share from 45 cents and might buy back $23.1 billion in shares.

Citigroup C raised its dividend to 51 cents a share from 45 cents and can repurchase $21.5 billion in stocks. Morgan Stanley (MS - Free Report) hiked its dividend to 35 cents a share from 30 cents and can buy back $6 billion in stock.

Shares of these companies naturally picked up. Morgan Stanley (up 1.2% on Jun 27), Citigroup (up 1.4%), Wells Fargo (up 1.1%), Goldman Sachs Group (up 1.2%) and JPMorgan Chase (up 0.3%) — all rallied on Jun 27.

Market Reaction

The news boosted the financial sector on Jun 27. U.S. Financials iShares ETF IYF and S&P 500 Financials Sector SPDR XLF gained about 0.9% and 1% each on Jun 27. The gains were undeterred by talks that the Fed might cut rates this year and despite the fact that the benchmark treasury yield’s 4-bp fall to 2.01% from the day before on a safe-haven rally.

Some parts of the yield curve have, in fact, inverted, which is a negative for bank stocks. Still, encouraging stress test results and a string of announcements about shareholder value maximization pushed financial ETFs northward.

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 (up 0.7% on Jun 27),XLF, Vanguard Financials ETF VFH (0.9%) and Fidelity MSCI Financials Index ETF FNCL (up 1.1% on) (see all Financials ETFs here).

Citigroup and Wells Fargo have special exposure to Invesco KBW Bank ETF KBWB (up 0.9% on Jun 27) and Oppenheimer Financials Sector Revenue ETF RWW) (up 0.7%). If anybody wants to steer clear of Goldman and Morgan Stanley-rich funds, they should know that the duo has substantial weight in iShares US Broker-Dealers ETF IAI (up 1.3%).

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