Banks have had a bit of a roller coaster ride over the past one and a half years, prompting some investors to remain on the sidelines.
We too were cautiously optimistic in our March report http://www.elgingamc.com/index.php/bulletin-board/ but not ready to make the move. We quote from our report “as the economy picks up, the potential for a long-awaited reversal in bond yields grows and that is promising for the financial sector in general”, “however we have to emphasise that there is no clear relative uptrend at the moment so investors might want to wait before jumping in”.
We believe the time has come as both recent economic developments and technicals support this. Take a look at the SPDR Bank ETF (KBE) below. The price that was trapped in the red shaded channel which lasted for about one and a half years has finally broken to the upside. Price retested the upper band of the channel (which now serves as support) and moved higher.
At the same time US economic data is improving, which increases the odds of the Fed rising interest rates this year. Thanks to Friday’s “good” news, the market has priced in just 5.86 months until the first Fed rate hike. This is now the soonest expected level for ‘tightening’ since April 2010.
And as a reflection of the news, yields are soaring. In the below chart we would like to point an intermarket relationship between the 10 Year Govt. Yield and the Relative Strength line of the SPDR Bank ETF (KBE). A Relative Strength (RS) line is a technical concept which divides the performance of the sector vs the S&P 500. A rising RS line indicates that the sector is outperforming (up more, down less) the index and the opposite happens when it’s falling. As the 10 Year Govt. Yield began to rise (red-shaded area), Banks started to outperform the broader market (S&P500).
Not all financial ETFs however are equal. Investors would need to know the composition of each ETF before investing, as it varies. One of the most widely used financial ETFs is the SPDR Financial Select Sector (XLF). It is the ETF that has the most volume (number of shares changing hands) and also the ETF with the most assets under management. Despite its popularity, XLF significantly lagged its lesser known counterparts. The chart below shows that in the last three months the SPDR Bank ETF (KBE) outperformed the SPDR Select Financials ETF (XLF) by 6.15%. The outperformance is huge considering that both ETFs invest in the same sector. The reason for this is their composition. In the case of XLF, only 35% is invested in banks which tend to benefit with rising interest rates while 15% is invested in REITs which are negatively affected by rising interest rates. YTD, REITs as measured by Vanguard REIT ETF (VNQ) are down by 5%. On the other hand, KBE is a pure Bank ETF hence the better results.
Our cautiously optimistic stance on financials has changed to favourable as both fundamentals and technicals point to further outperformance for the sector. Before investing however, investors should really be aware of the composition of the ETFs they get into. We advise ETFs with high exposure to banks as they will most likely benefit from a rising rate environment. Some names include SPDR Bank ETF (KBE), SPDR Regional Bank ETF (KBE) and iShares US Regional Bank ETF (IAT).
Costas Pierides CFTe MSTA
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