Financial ETFs Less ‘Stressed’ On Fed Results

News that most large U.S. banks passed the Federal Reserve’s stress test, and would now be able to increase buybacks and dividends, triggered hopes that perhaps the U.S. financial sector—this year’s worst-performing S&P 500 sector—might be ready to find a footing.

Financial ETFs such as the Financial Select Sector SPDR Fund (XLF | A-94)—the largest financial sector ETF, with $14.7 billion in assets, and a fund that holds several of these large banks among its top holdings—was rallying Thursday morning, posting gains of more than 1%.

The performance stood in contrast to what has been the worst performance among S&P 500 sectors this year.

XLF is still down roughly 4% year-to-date, and going back 12 months, those losses now exceed 7%. In times when investors are worried about the health of the global economy, financials tend to fall out of favor.

Low Rates Weigh On Financial ETFs

Persistently low rates across the globe haven’t helped banking bottom lines either.

The bank-focused SPDR S&P Bank ETF (KBE | A-78), for example, with $1.7 billion in assets, is another fund hurting this year, and one to find some respite on the heels of the stress-test results. Year-to-date, KBE’s losses exceed XLF’s, at more than 9.5%. But Thursday morning, it too was posting modest gains.

The modified equal-weighted portfolio of banks and thrifts has regional banks representing 74% of the mix, and diversified banks at 12%. J.P. Morgan is among KBE’s top holdings. 

Chart courtesy of StockCharts.com

Increased Dividends And Buybacks Coming

The results of the Fed’s stress test, designed to determine just how well banks would do in a recession, “show that big U.S. banks have not only built up significant capital since the 2007-2009 financial crisis, but that management teams have largely proven the merit of their internal disaster planning to the Fed,” Bloomberg reported.

Passing the Fed’s test will allow banks to begin offering dividends again and to buy back stock.

Bank of America already said it would buy back as much as $5 billion in shares to increase dividends to shareholders, the Wall Street Journal reported. That’s particularly noteworthy considering that would be only the second time since the financial crisis when the bank would have increased dividend payments.

J.P. Morgan and Morgan Stanley are also planning similar buybacks. That’s good news for shareholders of these banks, and for ETFs tapping into the beaten-down financial sector.

There is nearly $30 billion in assets tied to the approximately 40 financial-sector ETFs today, according to FactSet data. But the segment had been losing assets year-to-date. Investors have yanked a net of $2.8 billion from XLF so far in 2016, and nearly $500 million from the much-smaller KBE.

Contact Cinthia Murphy at [email protected].