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Why Financial ETFs Can Bounce Back

This article was originally published on ETFTrends.com.

The financial services sector, the third-largest sector weight in the S&P 500, has been a source of considerable disappointment for investors this year. The Financial Select Sector SPDR (NYSEArca: XLF) , the largest exchange traded fund dedicated to the sector, is off almost 10 percent this year, a decline that has materialized against the backdrop of three interest rate increases by the Federal Reserve.

Some market observers warned that banks may even be cutting back on lending as bankers are becoming more concerned over the late-cycle U.S. economy. Indicators such as credit-card charge-off rates have increased, though the rate leveled off over the summer.

However, the group is significantly oversold, which could give way to a near-term rally. In addition to XLF, the SPDR S&P Bank ETF (KBE) is another bank ETF that is well into oversold territory.

"I've been quite negative on the group all of this year until now," Matt Maley, equity strategist at Miller Tabak, said in an interview with CNBC. "You look at either the KBE or the KRE, its weekly RSI [relative strength index] chart is getting very oversold. In fact, the last three times it got this extreme, the group bounced very sharply."

Other Considerations

Furthermore, banks are expected to reveal a slowdown in their advising businesses as merger and acquisitions tapered off and bond and stock offerings slipped in the third quarter year-over-year.

Fund managers argued that banks have already hit peak earnings, pointing to some red flags such as the U.S. Treasury curve flattening as short-term yields rise in response to U.S. rate hikes from the Federal Reserve and long-term yields dip on growth and trade concerns. The flatter yield curve would typically diminish bank profits as they try to profit on the spread – short-term rates affect a bank’s borrowing costs and long-term rates limit how much they can charge on loans.

"Every single midterm election year going back to the 1950s has seen a rally in the last two months. I think that the groups that are really beaten up, that are washed out, are the ones that are going to do the best," said Maley in the CNBC interview. "You don't want to buy it all at once, but it's going to be a good group come December."

For more information on the market sectors, visit our sector ETFs category.

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