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Tap Financial ETFs Ahead of Q2 Earnings Season

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In spite of underperforming by a margin on a year-to-date basis, financial ETFs are recovering of late. And these could be better performers from in the second half of this year.

Cheaper Valuation

Cheaper valuation could be a tailwind as prices for bank stocks did not rise as much as the total market. “The financials sector offers the most attractive forecast total yield [ including dividends and buybacks] over the next 12 months, compared to the other S&P 500 sectors,” per a senior global equity strategistat Wells Fargo. In the current low rate environment, such a feature is extremely supportive.

Within the broader financial sector, Opppenheimer analyst Chris Kotowski is particularly bullish on large banks, writing in a note to clients that “the breadth, stability and qualityof [large banks] earnings has never been better,” as quoted on MarketWatch.

Positive Earnings Growth for Q2

Quarterly earnings releases from the sector will hit the market in full swing next week. Big banks are all set to report. Financial companies are expected to record 3.2% growth in earningsin Q2 after a 2.7% expansion. Revenue growth is expected to be 6.3% in the second quarter on 8.2% higher revenues.

The performance looks bright when compared with the broader market gains.The earnings slump of the large-cap S&P 500 is expected to be 2.9% on 4.3% higher revenues, per the Earnings Trendspublished on Jun 26, 2019.

Solid Performance in Fed Stress Test

Investors should note that U.S. banking biggies have cleared the key Stress Test conducted by the Federal Reserve in June, barring the U.S. division of Credit Suisse. Regulators allowed  majority of the 18 institutions to raise dividends and buy back shares (read: Big Banks Clear Fed's Stress Test, ETFs Rally).

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.

Dividend Hike Announcements

There was also a vortex of announcements of dividend hike. All six big banks – Goldman Sachs (GS - Free Report) , J.P. Morgan Chase JPM, Bank of America BAC, Wells Fargo WFC, Citigroup C and Morgan Stanley MS have announced dividend hikes.

Lesser Chances of a Steeper Fed Rate Cut

With jobs data for the month of June coming in upbeat, the chances of a steeper Fed rate cut have quelled a bit. If the Fed does not slash rates in the near term and the economy chugs along nicely, long-term interest rates may inch up in the coming days, steepening the yield curve a bit more. This would be a positive for bank stocks.

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, Financial Select Sector SPDR Fund (XLF), Vanguard Financials ETF VFH and Fidelity MSCI Financials Index ETF (FNCL) (see all Financials ETFs here).

Citigroup and Wells Fargo have special exposure to Invesco KBW Bank ETF KBWB and Oppenheimer Financials Sector Revenue ETF RWW. If anybody wants to bet on Goldman and Morgan Stanley-rich funds, they should know that the duo has substantial weight in iShares US Broker-Dealers ETF IAI.

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