Financial ETFs in Rally Mode

In a sign that the risk-on trade might be getting new life, ETFs tracking the financial services sector soared on Thursday. This could prove to be a crucial point toward extending a rally that has now gone beyond two months as financial services names are the second-largest sector allocation within the S&P 500 behind technology.

While volume is light, the Financial Select Sector SPDR (NYSE:XLF), the largest ETF by assets tracking bank stocks, is up nearly one percent and trading at its highest levels since May.

"XLF is starting to break out today," said Paul Weisbruch, Street One Financials vice president of ETF/options sales and trading, in a note. "XLF is trading at key levels (and we) would like to see a close here if not above $15 in XLF from a technical standpoint."

Wells Fargo (NYSE:WFC), J.P. Morgan Chase (NYSE:JPM), Bank of America and Citigroup (NYSE:C) combine for over 26 percent of XLF's weight. The fund has almost $6.5 billion in assets under management.

Weisbruch recommend watching other bank ETFs in conjunction with XLF. That list included the First Trust Financials AlphaDEX Fund (NYSE:FXO), the Vanguard Financials ETF (NYSE:VFH) and the Rydex S&P Equal Weight Financials ETF (NYSE:RYF). The Rydex S&P Equal Weight Financials ETF is thinly traded with average daily volume of less than 4,200 shares over the past three months, but on Thursday, volume in RYF has exceeded 9,300 shares.

"This financials rally seems to be led by the money center banks as well as brokerage and money management firms," Weisbruch added. "The iShares Dow Jones US Broker-Dealers Index Fund (NYSE:IAI) is a fund to watch closely here as well."

Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MS) combine for over 16 percent of IAI's weight. The fund has $41.3 million in AUM.

Weisbruch also noted the iShares MSCI Canada Index Fund (NYSE:EWC) is another ETF getting a lift from the rally in bank stocks. EWC devotes 33.2 percent of its weight to financial services names and four are found among the ETF's top-10 holdings. Each of EWC's top-three holdings are bank stocks. EWC is also trading at levels not seen since May.