Monday, March 9, 2015

Banking for a Win

It was no surprise that our weekly Quant Movers report looked a little “schizophrenic” after Friday’s panic-induced Treasury rout from another stellar Job’s report.  As the “risk-off” trade sparked strong selling across all asset classes, some of the biggest quant gainers for the week made for a mismatched list of market neutral, covered call and low volatility products with no clear trend to follow.  But there was one standout amidst the bloodletting last Friday, the PowerShares KBW Capital Markets Portfolio (KBWC). As the potential for a rising rate environment finally provides a much needed lift to the financial sector where profitability has long been constrained by tight interest rate spreads.  While it might be early to declare victory for the financials, the momentum shift does have us wondering if it’s time to get serious about bank stocks.

After showing so much promise last December when the on-going rally in low volatility sectors seemed to finally spillover to the financials, the sector fell flat on its face in January as traders and economists squared off on when rates might finally begin to rise in the U.S.  Constrained by low net interest margins, weak loan growth and stricter regulations that have all conspired to keep ROA close to historic lows, banking stocks (especially regional bank stocks that lack a trade desk) were the wallflowers in January with the Financial Sector Select SPDR down 6.96% and the KBW Regional Bank Index SPDR (KRE) down 9.46% to the S&P 500’s 3.1% loss.  How the worm turned last Friday with KRE gaining .77% compared to XLF’s -.74% and the S&P’s -1.42% performance on the day.  KRE wasn’t the only fund to see big gains on the day, the iShares U.S. Regional Banks ETF (IAT) and SPDR S&P Bank ETF both managed to deliver positive returns on the day.

The secret to their success is a formula familiar to investing greats like Warren Buffet; community and regional bank names that dominate their home markets through a strong footprint but rely on loans and investment/trust services to generate revenue.  Pittsburgh’s own PNC Group (PNC) fits neatly into this category along with BB&T Corp (BBT) and SunTrust Banks (STI) that have long battled each other for supremacy in the states of the old Confederacy.  Besides having similar asset bases and extensive geographic footprints, the three banks are common holdings across the regional bank ETF market and were up over 1% on Friday (PNC and BBT were up 1.29%, STI was up 1.7%) as investors interpreted the potential for rate hikes as early as this June as positive for those strong regional players.  That regional focus for KRE and IAT (where these three banks make up 25% of the allocation) helps explain a significant portion of Friday’s performance differential when compared to XLF’s more lackluster showing.  IAT’s average market cap is $14.9 billion compared to $66.1 billion for XLF.

And if a little smaller is good, than a lot smaller must be better right?  Investors looking for a bigger bang for their buck as rising return on assets and leverage boost return on equity back to historic norms might consider the First Trust NASDAQ ABA Community Bank ETF (QABA.) With an average market cap of only $1.6 billion and many of the 143 banks are located within a single state they were among the hardest hit by the consumer balance sheet recession of the last five years.  Investors worried about the risks that they’ll be acquiring besides geographic risk if they add QABA to their portfolio’s should look at our Red Diamond Risk scores; QABA currently sports an ETFG Red Diamond Risk rating of 2.82, one of the lowest among the bank stock ETF’s we’ve talked about today thanks to lower volatility and deviation scores.  But investors should note that those lower scores may be due to much lower transaction volumes for underlying holdings compared to either regional players like PNC or national operations like Citi.

Thank you for reading ETF Global Perspectives!

This material is not intended as an offer or solicitation for the purchase or sale of any security or other financial instrument. Securities, financial instruments or strategies mentioned herein may not be suitable for all investors.  Any opinions expressed herein are given in good faith, are subject to change without notice, and are only correct as of the stated date of their issue.  Prices, values, or income from any securities or investments mentioned in this report may fall against the interests of the investor and the investor may get back less than the amount invested.  Where an investment is described as being likely to yield income, please note that the amount of income that the investor will receive from such an investment may fluctuate.  Where an investment or security is denominated in a different currency to the investor's currency of reference, changes in rates of exchange may have an adverse effect on the value, price or income of or from that investment to the investor.

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