Reasons To Be Bullish On Financial ETFs

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October 21, 2013 5:30pm NYSE:IYG NYSE:VFH

financial banksThe financial sector is one of the best performers this year thanks to a reviving banking sector in the U.S. In fact, the recent rally in the equity market was mostly supported by financial stocks.


Banks are trying to reclaim their past glory, leaving behind the disgraceful series of hedging losses and scandals, and have rebounded over 200% in the last four years. Sound balance sheets, an improved asset market and lower loss provisions were the major contributors to this advancement, though a lot still needs to be done to reach the pre-crisis levels.

Recent Earnings in Focus

The star performance by the financial sector in the second quarter was highlighted by a beat ratio of 76.9% for earnings and 61.5% for revenues (read: 3 Bank ETFs Leading the Pack this Earnings Season).

Total earnings for the sector went up 30% on 8.5% higher revenues in the second quarter. In fact, if we take away finance from the set of all sectors, the growth picture becomes feeble in the second quarter on a sequential basis.

Now, let’s see how things are shaping up for this quarter’s announcements:

The sector seems to have lost some of its shine as compared to the second quarter. For this season, the financial sector is expected to expand 3.9% on the bottom line buy suffer 6.3% on the top line.

Needless to say, the figures are quite underwhelming sequentially. Tougher comparisons are deemed responsible for this slowdown.

Q3 Earnings So Far

So far, as much as 45.5% of the Finance sector’s total market capitalization is out with results. Total earnings from the sector are up 17.9% on 0.5% lower revenues. Of the pack, 63.3% of the companies surpassed earnings expectations and 36.8% came ahead of top-line estimates.

The mixed bag response in the sector so far can be validated by the latest earnings reports from sector bellwethers including Wells Fargo, JP Morgan Chase & Co. (NYSE:JPM), Bank of America Corp. (NYSE:BAC) and Citigroup (NYSE:C).

While JP Morgan missed the Zacks Consensus Estimates on both lines, Wells Fargo beat the bottom line but fell shy of the top line. BofA came ahead of the bottom-line estimate but posted in-line revenues.

Results in Focus

Wells Fargo earned $0.99 in third-quarter 2013, achieving the fifteenth consecutive quarter of earnings per share growth. Results improved from $0.98 earned in the prior quarter.

Closely controlled expense management led to the growth despite 4.2% sequential drop in total revenue. However, revenues were up 3.3% year over year.

Meanwhile, BofA delivered a positive earnings surprise of about 11.1%. Quarterly earnings also witnessed a marked improvement from the year-ago quarter’s break-even results. However, revenues were down 2% year over year.

On the other hand, JP Morgan ran into some turbulence in the third quarter, reversing its earnings streak. Net revenue of $23.9 billion was also down 8% year over year (see all the financial ETFs here).

Citigroup also posted dismal results in the third quarter.  Earnings were down year over year and also missed the Zacks Consensus Estimate. Adjusted revenues declined 5% and fell below the Zacks Estimate.

Market Impact

All the aforementioned companies have considerable exposure in funds like iShares U.S. Financial Services ETF (IYG), PowerShares KBW Bank (KBWB), Market Vectors Bank and Brokerage ETF (RKH), Financial Select Sector SPDR (XLF) and Vanguard Financials ETF (VFH).

All four ETFs gained in the last 10 days braving the much-hyped risk of debt default. In fact, the magnitude of gain was higher in these names than the S&P 500 index.

We believe, overall repositioning and emergence of the sector from the crisis in 2008 is sending the financials ETFs into rally. While a particular stock like Citigroup is underperforming, the strength from other counterparts like Wells Fargo and BofA are more than making up for the shortfall.

Also, the recent quarterly underperformances are believed to be short-lived, in some cases related to macroeconomic issues, which really do not spoil the core fundamentals.

In the year-to-date frame (as of October 16, 2013), barring RKH, the other four has returned more than 24%.  The return from RKH was also not bad at 16%. In fact, there is hardly any ETF in the U.S. financial equity space that is returning poorly.

Risk outlook for all the above-mentioned funds are ‘low’ with KBWB, XLF and VFH retaining Zacks ETF Ranks of #1 (Strong Buy) (read: Top Ranked Financial ETF in Focus: VFH).

Bottom Line

In such a scenario, there is reason to be bullish on financial ETFs, suggesting that both the near future and the long-term path could be smooth for investors. Just one word of caution is that the sector is highly vulnerable to various regulatory issues and interest rate fluctuations.

This article is brought to you courtesy of Eric Dutram.


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