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Are Bank Stocks & ETFs "Very Cheap" or More Pain Looms on?

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Amid the ongoing bear market in Wall Street, bank stocks got more battered than the S&P 500. SPDR S&P Bank ETF (KBE - Free Report) has lost about 38.7% in the past month compared with 20.6% decline in the S&P 500. Fears of default and decline in long-term bond yields amid a safe-haven trade are weighing on bank stocks and ETFs. The S&P financial sector is hurtling towards its poorest month in 30 years.

Investors should note that amid an economic slowdown, there are expectations of a rise in delinquency rates, affecting banks’ asset quality. Global companies are drawing down their line of credit, forcing banks to disburse large sums of money, per a Wall Street Journal article. With heightened expectations of economic depression doing the rounds, default of a line of credit is possible (read: Banking Earnings Mixed, ETFs Gain Moderately).

Will Fed & U.S. Stimuli Aid Banks?

In such a trying situation, global central banks are coming to the rescue of economies and markets. The Fed cut interest rates this month to zero (for the first time since the 2008 financial crisis) and also started an unlimited QE (read: All-Out Fed Support: Buy Highly-Rated Corporate Bond ETFs).

The Fed also confirmed that it will buy investment-grade exchange-traded funds that track the corporate bond market, “a first for the U.S. central bank,” per MarketWatch. Along with the Fed, there is the U.S. stimulus worth about $2 trillion. This fat incentive was meant to finance hospitals, businesses and ordinary Americans. This should inject ample liquidity into the U.S. economy and lower the chances of default. “The quantitative easing will support banks’ already strong liquidity,” per Moody’s.

Are Bank Stocks Undervalued?

Analysts noted that many bank stocks are “incredibly oversold” and “cheap on any level.” In fact, KBE’s Relative Strength Chart for last week was “at an all-time low,” as quoted on CNBC. JPMorgan’s (JPM - Free Report) RSI chart was the most oversold it has been “going back several decades,” per chief market strategist at Miller Tabak.

From the P/E point of view too, the financial ETFs space is cheap with the highest P/E of 19.60x held by iShares U.S. Financials ETF (IYF - Free Report) while First Trust Nasdaq Bank ETF (FTXO - Free Report) has a considerably low P/E of 11.34x. Meanwhile, SPDR S&P 500 ETF (SPY - Free Report) ’s P/E ratio was 19.67x.

Any Cause for Concern?

Along with other analysts we also believe that banks will now face a hard time making fee income because a lot of IPOs, M&A, all of that activity, is going to be delayed or postponed” amid global slowdown. Even if banks managed to register decent net interest margin, it is “smaller part of their revenue schedule these days.”

The growing risk of a global recession due to the rising coronavirus fears will likely hurt demand for high-quality loans too, which will cause trouble for the sector.

With cities on quarantine and activities coming to a standstill, demand for loans from household and corporations is likely to drop. The biggest American banks — known for shareholder value maximization — announced a suspension of buybacks. Notably, dividends and buybacks have been a lure for financial stocks so far (read: Why Bank ETFs May Soar in 2020).

ETFs in Focus

To conclude, it is important to note that banks’ cheaper valuation is undeniable. If there is any improvement in the reporting of coronavirus cases and risk-on sentiments, banks are likely to bounce back sharply. Until then, keep close tabs on KBE, Financial Select Sector SPDR ETF (XLF - Free Report) and IYF.

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