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Reasons to Reconsider Bank ETFs

This article was originally published on ETFTrends.com.

The SPDR KBW Bank ETF (KBE) is up 4.20% year-to-date, but with the Federal Reserve tightening interest rates, some investors expected more out of bank stocks and the related exchange traded funds.

Bank stocks and financial sector exchange traded funds may continue to strengthen as strong fundamentals help support this market segment’s outlook. Supporting the financial sector, U.S. banks revealed record quarterly profits to start 2018 as a result of the new tax laws, rising interest rates and improving economy.

“US business loan growth stumbled in 2015 when the economy hit a soft patch,” said State Street Global Advisors (SSgA) in a recent note. “While US GDP growth went on to rebound from its bottom in mid-2016, business loan growth continued its downward trend, reaching its lowest level since the recovery of the financial crisis in December 2017. Because companies often wait for strong signs that economic growth is sustainable before making plans to increase borrowing or expand their business, there is usually a lag between an economic rebound and business loan growth expansion.”

Long-Term View for Banks

Historical data suggest it can take bank stocks a while to feel the full effects of higher interest rates.

Looking at annual data from 1989 through 2015, bank stocks rallied 14.2% on average in the two years following cuts in the fed-funds rate, compared to the average 7.4% gains in the two years following a hike in the fed-funds rate. Additionally, while bank stocks increased 11.5% in the two years after yields declined, the sector saw 10.5% gains in the two years following an increase in yields.

“Despite a flattening yield curve, net interest margins continue to expand, which is a positive sign for banks’ corporate profits. While banks’ interest expense—the interest rates banks must pay on deposits—remain near zero, the interest rates that banks earn on their commercial and personal loans have increased as the Federal Reserve raises rates, boosting banks’ interest income,” according to SSgA.

Related: 12 U.S. Sector ETFs to Play in Case of an Escalating Trade War

Higher interest rates also have the potential to boost bank earnings.

“The industry’s 2018 estimated earnings-per-share growth has been adjusted higher to 24.4% from 22.6%, where it stood at the end of the first quarter,” said SSgA. “Analysts are projecting 12.5% earnings growth in 2019, outpacing 10.2% growth for the broad market.”

For more trends in the financial sector, click here.