As rates rise, investors should consider banks and financial sector-related exchange traded funds.
The S&P 500 financials sector is already outperforming in the new year, rising 5.4% last week over the first five trading days of January and marking the sector’s best start to a calendar year since 2010, the Wall Street Journal reports. In comparison, the broader S&P 500 index suffered a 1.9% pullback over the same period.
Many are anticipating that the rising interest rates will help bolster financial stocks and make the sector more attractive than the growth-oriented technology sector that helped power the previous market rally.
Last week’s rally in financial companies came after the Federal Reserve indicated midweek that officials could begin hiking interest rates as soon as March, which is faster than previously expected.
Even without higher rates, banks have still managed to strengthen off the backs of recent blockbuster profits, largely due to big gains in increased trading and deal-making activities.
“The backdrop for financial stocks is very favorable: Rising interest rates can boost bank margins, and a strong economy can lead to increased borrowing,” Greg McBride, chief financial analyst at Bankrate.com, told the WSJ.
Higher rates would also bolster banks’ bread-and-butter businesses, since they make money by charging higher rates on their loans compared to the payout on deposits.
“The spread between what you charge on loans relative to what you pay on deposits will begin to widen as rates rise,” Jason Goldberg, a banking analyst at Barclays, told the WSJ, recommending that investors position themselves in banks in 2022.
Looking ahead, central bank officials are anticipating at least three quarter-percentage-point rate increases this year, and some bankers are even looking for more.
“I’d personally be surprised if it’s just four increases,” JPMorgan chief executive Jamie Dimon said on CNBC. “It’s a very, very little amount and very easy for the economy to absorb.”
As investors look back into bank stocks, some may turn to broad financial sector-related ETFs to capture the rebound, including the Financial Select Sector SPDR (NYSEArca: XLF), the Fidelity MSCI Financials Index ETF (NYSEArca: FNCL), the iShares U.S. Financials ETF (NYSEArca: IYF), and the Vanguard Financials ETF (NYSEArca: VFH). The broad financial sector ETFs include hefty tilts toward big banks, but these broad sector plays also include other non-pure bank plays in the financial sector covering capital markets, insurance companies, diversified financial services, and consumer finance, among others.
On the other hand, investors can also turn to more bank-focused ETFs like the iShares U.S. Regional Banks ETF (NYSEArca: IAT), the SPDR S&P Regional Banking ETF (NYSEArca: KRE), the Invesco KBW Regional Bank Portfolio (NYSEArca: KBWR), and the SPDR S&P Bank ETF (NYSEArca: KBE). Potential investors should also note that State Street Global Advisors’ bank-related ETFs follow a more equal-weighted indexing methodology, so their holdings lean toward mid- or smaller-sized companies.
For targeted exposure to the small-sized banking segment, investors can look to options like the First Trust NASDAQ ABA Community Bank Index Fund (NasdaqGM: QABA) and the Invesco S&P SmallCap Financials Portfolio (NYSEArca: PSCF).
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