Bank ETFs Could Shine in Q4

Markets ETF Trends

Financial services exchange traded funds, including the Financial Select Sector SPDR (NYSEArca: XLF) and the SPDR S&P Bank ETF (NYSEArca: KBE), have endured their fair share of struggles of this year as the Federal Reserve has consistently held off on boosting interest rates, but bank stocks and ETFs could rally in the fourth quarter.

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Heading into this year, many market observers expected four Fed rate hikes, a number that subsequently dropped to two and now, in the eyes of some experts, zero. Higher interest rates would help widen the difference between what banks charge on loans and pay on deposits, which would boost earnings for the financial sector.

SEE MORE: Bullish Signs for Bank ETFs

With a steepening yield curve, or wider spread between short- and long-term Treasuries, banks could experience improved net interest margins or improved profitability as the firms borrow short and lend long.

Some market observers see the second-largest sector allocation in the S&P 500 as being a valid bullish play for the last three months of the year.

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“Fears that a systemic event lurks in the shadows of our banking sector aren’t based in fact. US banks look nothing like the institutions that were falling into the abyss during the dark days of the financial crisis. Dodd-Frank and other legislation have done their job, and for some critics (i.e. yours truly), may have done their job all too well,” reports Yahoo Finance.

Financial entities like banks will benefit from expanding margins as rates climb. A rising rate environment may reflect a strengthening U.S. economy, and a healthier economy would help borrowers have an easier time repaying loans, with banks stuck with fewer non-performing assets. Moreover, rising rates means that banks will generate greater revenue from the spread between what they pay deposit savers and the prime rates they charge credit-worthy clients and other highly-rated debt.

Related: 6 Bank ETFs’ Moment in the Sun

Financial services firms, like capital markets, banks and regional banks, are among the top three industries with the highest sensitivity to changes in the 10-year Treasury yield.

“Banks have been a major source of concern for most of the last few years. First, there is the nagging issue of net interest margins, or NIM, which have been under pressure for years. Periodically, banks make a run for higher ground on the hopes a Fed hike would help their cause. September disappointed once again, but banks this time seem a little more resilient. With market multiples stretched, banks represent one of the last sectors where valuations are respectable. Any good news could spark a catch-up rally,” according to Yahoo Finance.

For more information on the banking sector, visit our financial category.

Financial Select Sector SPDR

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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