Bank ETFs in Red Over the Past Month: Pain or Gain Ahead?

Interest rates are on the decline, U.S.-China trade tensions have heightened and markets have been on a wild ride of late. Against this backdrop, the largest banks of the United States reported earnings. The economic signal from these bank results remains positive so far despite concerns over non-bank lenders, especially after a few recent bankruptcies.

Wall Street credit concerns have resurfaced lately, following a warning from JPMorgan Chase JPM CEO Jamie Dimon about “cockroaches” in the U.S. economy, as quoted on Yahoo Finance. Note that on Thursday, shares of regional banking shares suffered due to fresh signs of credit stress in the banking sector.

Zions Bancorporation plunged 13% on the day and Western Alliance Bancorporation fell nearly 10% after both disclosed losses tied to troubled business loans (read: ETFs to Gain Amid Latest U.S. Regional Banking Worries).

Vanguard Financials Index Fund ETF VFH has lost 4.5% over the past month, whileSPDR S&P Bank ETF KBE has fallen 9%. These returns came against a 0.1% uptick in SPDR S&P 500 ETF Trust SPY.

Is More Pain Ahead?

The capital markets segment is finally delivering results after several quarters of management highlighting improving deal pipelines. While activity has remained low by historical standards, the favorable regulatory and monetary policy environment makes it reasonable to be optimistic about the sector’s prospects.

Consumer spending and household finances remain stable, supported by a decent labor market. Credit demand shows signs of improvement and delinquencies have declined from their peaks despite references to so-called ‘cockroaches.’

For the Finance sector, we now have third-quarter results from 47.7% of the sector’s total market capitalization in the S&P 500 index. Total earnings for these Finance sector companies grew more than 20.4% from the same period last year on 10.9% higher revenues, with 96.2% beating EPS estimates and 88.5% beating revenue estimates.

JPMorgan Chase & Co. (JPM), Wells Fargo & Company WFC, Citigroup Inc. C, Goldman Sachs GS, Morgan Stanley MS and Bank of America BAC beat both top and bottom-line estimates in their latest earnings releases.

Upbeat Zacks Ranks

The Finance sector ranks fifth out of the 16 Zacks classified sectors. The Financial - Investment Bank category, which most big banks come from, is also strongly positioned at present. The industry ranks in the top 14% of the 243 industries classified by Zacks.

Cheaper Valuation

The financials sector currently trades at a forward price-to-earnings multiple of 10.97X versus 19.88X possessed by the S&P 500. The Financial - Investment Bank industry trades at a forward P/E of 15.61X.

Projected EPS Growth of the sector is a solid 8.41% versus the S&P 500’s growth of 6.88%. The Financial - Investment Bank industry’s growth is 14.45%. The financials sector currently has a lower debt-to-equity ratio of 0.34X than the S&P 500’s 0.58X. The Financial - Investment Bank industry’s debt-to-equity ratio is even lower at 0.15X.

Steepening Yield Curve in the Cards?

The Fed is currently cutting interest rates. If risk-on sentiment in the market holds (assuming the so-called AI bubble doesn’t burst), long-term bond yields are likely to rise, while short-term yields will decline due to the Fed’s rate cuts.

This would steepen the yield curve — a positive for the banking sector — by boosting banks’ net interest margins. However, healthy credit demand is necessary to support gains in the net interest margins.

Bank ETFs in Focus

Against this backdrop, financials exchange-traded funds (ETFs), such as iShares U.S. Financial Services ETF IYG, iShares US Financials ETF IYF, Invesco KBW Bank ETF KBWB, Financial Select Sector SPDR XLF and Vanguard Financials ETF VFH, should gain ahead.

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This article originally published on Zacks Investment Research (zacks.com).

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