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Expect an Explosive Rally in Top-Ranked Bank ETFs

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Banks were hit hard at the peak of the COVID-19 pandemic due to the likelihood of higher default rates on loans as well as rock-bottom interest rates. However, with easing social distancing restrictions and the return of risk-on trade sentiments, long-term bond yields should jump higher in the near term. This should benefit financial stocks that perform well in a rising rate environment (read: 5 Sector ETFs Just Got Upgraded to Buy).

Morgan Stanley strategists recently added a bet on a steeper Treasury yield curve, seeing the potential for a “regime shift” amid a rapidly improving U.S. economy. “In the blink of an eye, that seems about how quickly the economic narrative has tilted in favor of a V-shaped recovery versus a slow and prolonged one,” said Guneet Dhingra, head of U.S. interest-rates strategy in New York, as quoted on bloomberg.

The strategist suggests that as 30-year yields have led longer-dated rates higher after a period, it’s time for 10-year rates to play the key role, if we go by history. The bank added a bet on the widening spread between three-year and 10-year yields and on five-year to 30-year spreads. The record job creation in May prompted such a move (read: 4 Sector ETFs & Stocks to Buy on Record Jobs Gain in May).

The benchmark 10-year U.S. Treasury yield jumped to 0.91% on Jun 5, 2020 from 0.66% at the start of the month. On the other hand, the three-month U.S. treasury yield has gained from 0.14% to 0.15% so far this year (as of Jun 5, 2020). Moreover, the Fed and the government have been taking care of the liquidity position of corporates and households by launching unprecedented stimulus.

Against this backdrop, below we highlight a few top-ranked financial ETFs that could be wining bets right now. These funds have a Zacks Rank #2 (Buy).

SPDR S&P Bank ETF (KBE - Free Report)

The fund puts 74.2% weight in regional banking, followed by diversified banks. No stock accounts for more than 2.40% of the fund. KBE charges 35 bps in fees.

Financial Select Sector SPDR Fund (XLF - Free Report)

The fund puts about 38.4% in banks, followed by 25.1% in capital markets, 18.4% in insurance and 13.3% in diversified financial services. The fund charges 13 bps in fees. Berkshire Hathaway (13.2%), JPMorgan Chase (11.8%) and Bank of America (7.7%) are the top three holdings of the fund.

Vanguard Financials ETF (VFH - Free Report)

Diversified Banks (25.4%), Regional Banks (13.7%), Financial Exchanges & Data (10.2%), Property & Casualty Insurance (8.5%), Asset Management & Custody Banks (8.5%) and Multi-Sector Holdings (8.20%) are the industry holdings of the fund. JPMorgan Chase, Berkshire Hathaway and Bank of America are the top three holdings of the fund. VFH charges 10 bps in fees.

First Trust Financials AlphaDEX Fund (FXO - Free Report)

FXO seeks to outperform the U.S. financials sector by tracking a proprietary index of stocks selected from the Russell 1000 Financial Services Index. The 100-stock fund charges 63 bps in fees.

Invesco KBW High Dividend Yield Financial ETF (KBWD - Free Report)

The 41-stock fund’s top holdings include Orchid Island Capital (4.61%), Prospect Capital Corp (4.49%) and Apollo Global Management Inc. The fund charges 35 bps in fees.

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