A strong economy and rising interest rates are supposed to be good for banking stocks, but the financial sector is the third-worst performing sector in 2019, just ahead of energy and materials.
The financial sector is down 14.4 percent year-to-date, with the banks dragging down results. That compares to the broader Standard & Poor’s 500 being down 6.2 percent for the year.
Market watchers say a confluence of factors are pummeling banks. Fred Cannon, global director of research and chief equity strategist for KBW, says rates rising above zero helped the banks. But that tailwind turned into a headwind when rates reached 1.5 percent to 2 percent because that caused deposit costs to rise, which lessened the benefits of higher interest rates.
Short-term rates are rising faster than long-term rates, flattening the yield curve and compressing bank’s net-interest margin, says Pat O’Hare, chief market analyst for Briefing.com. Continued signs of a slowing housing market prompt worries about mortgage-loan demand, and that has hit regional banks.
Banks received an initial boost from last year’s tax cuts, based on hopes it would spur loan growth, but that didn’t really occur, Cannon adds.
O’Hare says stock-market volatility pinched investment banks like Citigroup and Goldman Sachs that are seeing by lower trading volume and reduced initial public offering activity as investor confidence wanes. Global growth concerns and the accompaning impact on loan demand and banking activity have added to the sector’s woes.
Bank stock weakness calls into question whether the economy is doing that great. “It's just a one more negative for investor sentiment because bank stocks are not acting the way that you would expect them to act if the market truly believed there was a really promising growth outlook,” O’Hare says.
Three top bank ETFs—the SPDR S&P Bank ETF (KBE), Invesco KBW Bank ETF (KBWB) and First Trust Nasdaq Bank ETF (FTXO)—reflect these concerns. These three have similar constituents but their weighting methodologies differ.
The biggest is KBE, both in terms of its $2.57 billion in assets and its 81 holdings, which give it the broadest industry exposure. It has an expense ratio of 35 basis points and follows the S&P Banks Select Industry. Eighty-nine percent of the fund composed of banks, with 4.3 percent devoted to property and casualty insurance, and 3.5 percent for investment management and fund operators. The top three holdings are LendingTree (1.8 percent), and Bank of New York Mellon and Signature Bank (both at 1.7 percent).
With its equal weighting, it’s more of a mid-cap product with an average weighted market cap of $27.9 billion. KBE is down 21.3 percent year-to-date, but is up 4.8 percent and 4.2 percent on an annualized three- and five-year basis.
KBWB from Invesco is a domestic market-cap weighted index with only 24 holdings. That market-cap weighting boosts its average market cap to around $105 billion, significantly bigger than the other two funds. Banks comprise 85 percent of the holdings, with investment management and fund operators at 11.4 percent, and consumer lending firms at 4 percent.
Its top three holdings are U.S. Bancorp at 8.9 percent, JPMorgan Chase at 8.7 percent and Wells Fargo at 8.1 percent. It has a 35 basis-point expense ratio and $680 million in assets. KBWB is down 19.35 percent year-to-date, but has an average three-year gain of 7.5 percent and a five-year gain of 6.3 percent.
The FTXO fund from First Trust is a smart-beta product tracking the Nasdaq US Smart Banks Index, which holds 30 U.S. banking companies and ranks and weights them by volatility, value and growth factors. The fund caps holdings at 8 percent at rebalancing. It sits firmly in the large-cap side of the style box, with an average market cap of $78 billion.
The fund is down 23 percent year-to-date, and doesn’t have longer-term track records because it launched in September 2016. The expense ratio is 60 basis points and there’s $181 million in AUM. Its top three holdings are U.S. Bancorp at 9 percent, JPMorgan Chase at 8.9 percent and PNC Financial Services Group at 8.4 percent.
While it seems the banking sector weakness picked up speed late this year, both Cannon and O’Hare say bank stocks and the ETFs that track them have struggled since early 2018. Cannon notes that bank ETF outflows started in March, while O’Hare says the sector peaked in the first quarter and he suggested with some hindsight that banks might have foreshadowed current market worries.
If banking ETFs are stinking up the joint even as the U.S. economy remains in good shape, what will happen when a recession hits? Advisors may have to think counterintuitively, O’Hare says, noting it could be a buying opportunity because it’s likely banking stocks have priced in that weakness. Recession calls are usually backward-looking, but he says a buying sign for banking ETFs would be when the gross domestic product data turns negative.