By Jacob Sonenshine
The rally in financial stocks is taking a breather. For investors who haven’t gotten into the sector yet, this might just be the best buying opportunity to come around.
The Financial Select Sector SPDR fund, a diversified exchange-traded fund of financial companies on the S&P 500, gained 21% to a peak of $37.99 earlier this month from a multi-month low in October.
But since that peak, the ETF — which owns asset manager BlackRock, investment banks JPMorgan and Goldman Sachs, more lending-focused banks Wells Fargo and Bank of America, and other financial giants — has retreated about 1%.
Before the rally’s pause, a dip in short-term interest rates had driven financial stocks higher. Lower rates can boost consumer demand, a benefit for lenders, even though they reduce the rates that these banks can charge. Lower borrowing costs also help investment banks complete more deals. Falling rates help nonbank players, too: Visa and Mastercard typically see stronger consumer spending when rates decline, for instance.
The good news is the sector’s stock decline this month looks more like a brief pause rather than the start of a of a larger drop.
Katie Stockton, founder and chief market technician at Fairlead Strategies has “seen a bullish shift that suggests XLF will resolve higher without a major pullback,” she wrote.
First off, the ETF is seeing support above $35, which means buyers have been coming in to stabilize the price fairly quickly around that level.
Secondly, while the financial sectors’ recent move back into favor with investors has been convincing, it has only just begun.
The rise in the ETF has outpaced the S&P 500’s gain since late October by several percentage points, but investors should remember that its previous underperformance lasted much longer. In the past 12 months, the ETF has gained about 8%, roughly a third of the S&P 500’s rise. The fund is still trying to reclaim its record high of just over $41 hit in early 2022.
The early nature of the rally is reflected in valuation as well: The financial sector is still cheap, as markets have been wary of a possible economic slowdown. The ETF trades at 12.5 times analysts’ expectations for per-share earnings for its holdings in the coming year. When compared with the S&P 500’s 19.6 times, that just about marks the ETF’s largest discount in the past 10 years, according to FactSet.
Lastly, real developments within the economy and financial markets lie behind the sector’s positive technical trading trends, as well as its potential for continued stock gains. The rate of inflation has been slashed by more than half from its 2022 peak — though at just over 3% is still above the Federal Reserve’s 2% target. The Fed is expected to start cutting interest rates later this year. That would support asset prices, continued economic growth, and growing revenue for financial firms — a winning combination for financial stocks.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com