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Investors are stepping up their bets on bank stocks via exchange traded funds following the sector’s historic 40% pullback.

Financial Select Sector SPDR (NYSEARCA:XLF) is up nearly 14% over the past month, outperforming the S&P 500’s roughly 10% rally.

The financial sector fund is frequently the second-most traded ETF on market, showing average daily volume of about 39.3 million over the last 50 days, reports Ryan Vlastelica for Reuters. Bank of America (NYSE:BAC) shares averaged 36.7 million.

“Bank stocks have pulled back 40% since their highs earlier this year over concerns of European sovereign debt issues (and spillover impact), fears of a slowing global/U.S. economy and continued political/regulatory unknowns/risks,” Deutsche Bank analysts wrote in a report earlier this month.

The financial sector has bounced sharply in October as major banks such as Citigroup (NYSE:C) and B. of A. report quarterly results. Bank stocks have been volatile with fundamentals “seemingly not mattering much right now and political actions increasingly unpredictable,” the Deutsche Bank analysts said.

If Europe can somehow sort out its debt crisis and shore up sentiment on the banking sector, financial ETFs could lead the market higher. Technical analysts want to see strength in financial stocks to confirm the recent breakout in the S&P 500 from its trading range.

“Volume is surging because investors have vastly different opinions on the sector,” Paul Justice, director of North American ETF research at Morningstar, said in the Reuters story. “With banks, investors are constantly dealing with large issues that could go either way, so they’re casting votes of different magnitudes in different directions. There’s high volume because there’s high volatility, and a great deal of short interest as well.”

Due to the mixed earnings results from individual banks, investors have been using the broad ETF plays in an attempt to avoid specific company problems.

“ETFs are a way for people who have a view of a sector rather than specific companies to play the trade,” Michael Iachini, managing director of ETF Research at Schwab, said.

The financial ETF has climbed above its 50-day moving average, a closely watched technical indicator.

From Feb. 14 through Oct. 3, bank stocks fell 40% before recovering this month.

“In the 45 years of daily bank stock performance data we have available, this was only the sixth such decline and fourth if we combine three 40%-plus declines in 2008/2009 (there were two 20%-plus rallies separating these sell-offs),” according to Deutsche Bank.

Financial Select Sector SPDR

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Max Chen contributed to this article.

Disclosure: None

Source: Investors Bet On Bank Sector ETFs Following 40% Decline