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Why Bank ETFs May Soar in 2020

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Bank ETFs have been a tear lately after a period of volatility. A flattening yield curve was a major concern in mid-2019. But talks of a mini trade deal between the United States and China bode well for banks. Overall, the year has been great for banks as the Banks - Major Regional industry (up 32.4%) has beaten the broader market this year (up 25.2%).

The industry has added 11.2% in the past month (as of Nov 13, 2019) versus 4.3% gains seen in IVV. The last three-month performance has also been upbeat with banks (up 19.7%) surpassing the S&P 500 (up 7.72%) (read: Risk-On Sentiments Are Back: ETFs to Play).

Let’s take a look how the space is evolving for 2020.

Deposits Are Rising

Per an article published on Wall Street Journal, deposits across the largest U.S. banks grew 5.8% year over year in the third quarter — the fastest pace since the start of 2017, according to Federal Reserve figures. As much as 89% of large U.S. banks’ total liabilities are now deposits, the highest proportion since 1979, according to Federal Reserve.

Since Autonomous Research expects interest-bearing deposit costs at big banks to decline roughly 0.15-percentage point from the third quarter to the fourth, such huge deposits could act as a great source of funding for banks. Deposits are the cheapest form of liability versus bonds or short-term borrowing.

Investors should also note that the noninterest-bearing deposits grew by a median 0.1% sequentially in the third quarter across the biggest banks, marking the first sequential jump in at least five quarters, according to JPMorgan Chase analysts, quoted on Wall Street Journal.

Solid Dividend Payments

Bank stocks are often known for their dividends. Historical dividend growth of The Banks - Major Regional industry is 12.25% versus 5% boasted by the S&P 500 ETF iShares Core S&P 500 ETF (IVV - Free Report) . Dividend yield of the space is 2.85% against 1.84% of the S&P 500.

Huntington Bancshares (HBAN - Free Report) (yields 4.08% annually), KeyCorp (KEY - Free Report) (yields 4.06% annually), and Wells Fargo (WFC - Free Report) (yields 10.70% annually) are some of the highest-yielding dividend stocks

Per morningstar, many bank stocks offer dividend payout ratios in the range of 30% to 40%. Analysts consider “current dividends and payout structures as stable” and believe that dividend payouts should not come under pressure in any occasion of economic slowdown.

Banks would rather adjust their share buybacks, if at all there is any earnings pressure, if we go by the article published on morningstar. Invesco KBW High Dividend Yield Financial ETF (KBWD - Free Report) is a good way to play this trend. The fund yields 8.51% annually (read: Worried About Dividend ETFs' Rally? 5 Low P/E Plays for You).

Cheaper Valuations

Major regional banking stocks are undervalued at the current level. The space currently has a P/E of 12.30x versus 18.64x boasted by IVV. Price-to-Book ratio is 1.31x versus 5.00x of IVV. PEG ratio of big banks stands at 1.50x versus 2.10x of IVV.

U.S. GDP Solid, if Not Great: Powell Unlikely to Cut Rates Ahead

The U.S. economy grew an annualized 1.9% in the third quarter of 2019, surpassing expectations of 1.6%, following a 2% uptick in the previous three-month period. The unemployment rate is hovering around a 50-year low level. Against this backdrop, Fed chief Powell sees no need for a rate cut in December. No more Fed policy easing could be good news for bank stocks (read: U.S. Q3 GDP Better Than Expected: ETFs to Benefit).

Against this backdrop, we highlight a few bank ETFs that have a Zacks Rank #2 (Buy).

Financial Select Sector SPDR Fund (XLF - Free Report)

Vanguard Financials Index Fund ETF Shares (VFH - Free Report)

First Trust Financials AlphaDEX Fund (FXO - Free Report)

Any Wall of Worry?

No matter how big an amount a bank has in its deposits, utility of the same declines if there is limited loan growth. Notably, loan growth in the third quarter was 0.7%, down from 1.1% in the second quarter, for the biggest banks.

Also, if customers are keeping so much cash in non-interest-bearing accounts, it could be a sign of an impending recession. Competitive environment among big banks for client acquisition will also remain cut throat, per the article published on Wall Street Journal.

Finally, a lot depends on trade. If there is no meaningful trade deal ahead, long-term bond yields may slide, spelling trouble for banks. But if the opposite happens, bank stocks will soar.

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