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Profit From Higher Rates With Leveraged Financial ETFs

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The financial stocks have been surging lately in anticipation of another Federal Reserve rate hike, which is driving the yields higher. This is especially true as 10-year Treasury yields climbed to 3.11%, near its highest level of the year, just ahead of the two-day meeting concluded later in the day. Two-year yields hit a high of 2.842% -- the highest level since Jun 25, 2008.

The central bank is expected to raise interest rates for the third time this year by 25 bps to 2-2.25% in its meeting. This would mark the eight rate hike since December 2015. Per the CME Group’s FedWatch Tool, interest rate futures traders are fully pricing in a third rate increase at the September meeting (read: ETFs to Win & Lose as Third Rate Hike Looms).

Growing inflationary pressure, an accelerating job market and a booming economy are compelling the Fed for aggressive rates hike. In the latest Fed minutes, the Federal Open Markets Committee (FOMC) provided an upbeat view of the economy, solidifying chances of a rate hike at the September meeting.

Notably, an upbeat August job report has bolstered the case for a faster-than-expected rates hike once again. The U.S. economy added 201,000 jobs in August, representing 95 consecutive months of job additions -- the longest growth streak. Meanwhile, average hourly wages accelerated 10 cents to $27.16, taking the year-over-year increase to 2.9%, the biggest yearly rise since April 2009. The unemployment rate remained stable at nearly a two-decade low of 3.9% (read: September Rate Hike Odds Rise: Top Sector ETF & Stock Picks).

The American economy has been on a solid growth path with GDP growth expanding 4.1% annually in the second quarter, representing the fastest pace of growth in nearly four years. Further, Americans are most optimistic about economic growth with consumer confidence hitting an 18-year high.

A Boon for Banks

A rising rate environment is highly beneficial for the financial sector, as it would bolster profits for banks, insurance companies, discount brokerage firms and asset managers. Notably, banks are in the most advantageous position. This is because they seek to borrow money at short-term rates and lend at long-term rates. With the steep rise in long-term interest rates, banks would be able to earn more on lending and pay less on deposits. This would expand net margins and bolster banks’ profits.

Investors are pouring huge levels of cash into bank-focused ETFs. The ultra-popular Financial Select Sector SPDR Fund XLF has pulled in $1.1 billion last week, the most since December. Meanwhile, SPDR S&P Regional Banking ETF KRE saw inflows of $534 million in capital last week, representing its largest weekly inflow since early December (see: all the Financial ETFs hereall the Financial ETFs here).

Given the massive inflow and rising rates, the appeal for financial ETFs have raised. As a result, investors who are bullish on the sector right now may want to consider a near-term long. Fortunately, with the advent of ETFs, this is quite easy as there are many options to accomplish this task. Below we highlight them and state how each stands out among the rest.

ProShares Ultra Financials UYG

This fund seeks two times (2x) leveraged exposure to the Dow Jones U.S. Financials Index, charging 95 bps in fees. It has amassed $909.3 million in its asset base and trades in a moderate volume of around 97,000 shares per day on average. UYG has returned about 1.2% over the past week.

ProShares UltraPro Financial Select Sector FINU

Investors having a more bullish view and higher risk appetite may find FINU interesting as the product provides three times (3x) exposure to the daily performance of the S&P Financial Select Sector Index. It has been able to manage $46.2 million in its asset base and trades in a lower volume of about 27,000 shares per day on average. Expense ratio is 0.95%. FINU was up 4.8% in the same timeframe (read: Here's Why Should You Buy Financial ETFs).

Direxion Daily Financial Bull 3x Shares ETF FAS

This product also provides three times exposure to the Russell 1000 Financial Services Index. Though it charges an annual fee of 95 bps, it is extremely popular with AUM of $2 billion and trades in heavy volume of around 1.5 million shares. The fund has gained 2% in the same timeframe.

Direxion Daily Regional Banks Bull 3x Shares DPST

This fund seeks to deliver thrice the returns of the S&P Regional Banks Select Industry Index, charging 95 bps in fees per year. DPST has accumulated $37.7 million in its asset base and trades in lower volume of around 26,000 shares a day on average. The fund has shed 0.2% in the same timeframe.

Bottom Line

As a caveat, investors should note that such products are suitable only for short-term traders as these are rebalanced on a daily basis (see: all Leveraged Equity ETFs here).

However, for ETF investors, who are bullish on the financial sector for the near term, either of the above products could make an interesting choice. Clearly, a near-term long could be intriguing for those with high-risk tolerance, and a belief that “trend is the friend” in this corner of the investing world.

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PRO-ULT 3X FINL (FINU): ETF Research Reports
PRO-ULT FINL (UYG): ETF Research Reports
SPDR-FINL SELS (XLF): ETF Research Reports
SPDR-KBW REG BK (KRE): ETF Research Reports
DIR-FIN BULL 3X (FAS): ETF Research Reports
DIR-D RG BK BL3 (DPST): ETF Research Reports
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