Following Friday's Brexit-induced tumble of nearly 5.4 percent, the Financial Select Sector SPDR Fund (NYSE:XLF) is down 7.3 percent. Combine Brexit with the Federal Reserve's refusal to raise interest rates this year, and the financial services sector, the second-largest sector weight in the S&P 500, is facing plenty of headwinds.
Banking Stress Test And Headwinds
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However, this some good new for financial services stocks and the relevant ETFs overshadowed by current macroeconomic affairs. Results from the first stage of this year's U.S. bank stress tests indicate improved health for major banks, including some that are found in XLF's lineup.
This year's stress test results underscore improving resilience with solid results despite a severely harsher scenario that included a more severe downturn than previous tests and negative short-term US Treasury rates, Fitch Ratings says. All 33 US bank holding companies passed the minimum capital ratio requirements. Tested firms overall generally performed better, posting higher capital ratios and smaller declines in capital ratios than in the past, said Fitch Ratings.
Related Link: Post-Brexit Analysis Shows Many ETFs Did Their Jobs
Still, interest rates are a concern for investors considering XLF and rival ETFs. Nearly two-thirds of XLF's weight is allocated to banks that would benefit from higher interest rates, underscoring the dichotomy of the current environment facing financial services ETFs.
However, better stress results could portend increased shareholder rewards for financial services investors. As it is, many of XLF's big-name holdings have boosted dividends and buybacks in significant fashion as stress test results have improved over the past several years.
Patient investors could be rewarded with bank stocks and ETFs in the form of consistently rising dividends. The financial crisis undid decades' worth of dividend ebullience from big banks in short order, leaving some income investors scorned and doubting the sector's future dividend growth prospects.
The largest global banks generally performed better than last year, although they still account for over half of projected losses under the severely adverse scenario, since they are subject to global market shock and counterparty default component. Pre-provision net revenue (PPNR) projections were noticeably higher this cycle, particularly for the five largest global trading and universal banks - Goldman Sachs Group Inc (NYSE:GS), JPMorgan Chase & Co. (NYSE:JPM), Morgan Stanley (NYSE:MS), Citigroup Inc (NYSE:C) and Bank of America Corp (NYSE:BAC). This more than offset higher losses from the stress scenario and may mean that some large global firms that typically revised capital plans post-DFAST won't do so this year, said Fitch.
JPMorgan Chase, Bank of America, Citigroup, Goldman Sachs and Morgan Stanley, in that order, combine for nearly 21 percent of XLF's weight.
Disclosure: Todd Shriber owns shares of XLF.
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