Bank ETFs In Trouble?

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Includes: BAC, C, GS, JPM, KBE, KBWB, KRE, MS, UBS, WFC
by: Zacks Funds

While global growth worries were prevalent to start 2016, impacting the otherwise steady U.S. economy, and oil prices giving a new shock every day, the recent selloff in the U.S. banking sector seems to be the final nail in the coffin.

In any case, the financial sector can be considered as the backbone of an economy. The sector accounts for around one-fifth of the S&P 500 index. Thus, a 3.2% decline in the KBW Bank index along with a lackluster outlook has given investors every reason to fret over the future.

The latest selloff in banking stocks was spurred by the UBS Group AG's (NYSE:UBS) moderate earnings for the fourth quarter of 2015. The bank's outlook was more worrisome as it indicated several macroeconomic headwinds and geopolitical issues to bother operations in the near term.

The bank talked about "very low levels of client activity and pronounced risk aversion." The bank reported 3.4 billion Swiss francs ($3.3 billion) of outflows from its wealth management arm, which looks after money from rich people outside the U.S. All in all, fears of a broad-based global slowdown spooked investors who rushed to dump banking stocks.

This was because of the fact that a slowing economy means reduced capital market activity, lower loan growth and high chances of credit default especially from the energy sector. All these lead to speculation that we may be on the verge of another recession. Following its earnings release, UBS was down 7.8% on February 2.

Bond Yields Are Falling

Plus, the sole hope for the financial sector - the rising rate environment post Fed tightening - failed to materialize. The benchmark U.S. 10-year Treasury note yield slipped to 1.87% on February 2, 2016 (down 10 bps in just a one day) while the yield on the short-term Treasury note (one year of maturity) rose to 0.54% on the same day (up 7 bps in one day). The tightening gap between the short and long-term yields has been a cause of concern for the banking sector.

The spread between the two-year and 10-year Treasury yields tapered the most since January 2008, as per Bloomberg. Notably, yield on the two-year U.S. Treasury note was 0.75% on February 2, 2016 (down 6 bps in one day). Narrowing spread between long- and short-term rates hurts net interest margin, which a key metric for the banking sector.

Basically, a bid for safety amid global market concerns was behind the decline in bond yields. Plus, the dimming prospects of further Fed rate hikes following a soft GDP report for the fourth quarter ruined the case for a rising rate environment. The year-end weighted average forecast in a Bloomberg survey has declined to 2.69%, from about 3.2% six months ago.

If this was not enough, Goldman Sachs Group Inc. (NYSE:GS) lost the most since November 2012 on February 2 on the news that the company's Asia unit was publicly censured by the Hong Kong Securities and Futures Commission (SFC). GS was down about 5% on February 2.

Citigroup (NYSE:C) and Bank of America Corporation (NYSE:BAC) were off 4.9% and 5.2% on the same day. Morgan Stanley (NYSE:MS), JPMorgan (NYSE:JPM) and Wells Fargo (NYSE:WFC) retreated 4.7%, 3.1% and 2.2% respectively. Each of these stocks has a Zacks Rank #4 (Sell) and belongs to an industry which is in bottom 18% of the Zacks Universe.

ETF Impact

Below, we highlight a few bank ETFs that lost considerably on February 2, in tune with the broad-based banking selloff.

PowerShares KBW Bank (NASDAQ:KBWB), with considerable exposure to Wells Fargo, JPMorgan and US Bancorp, lost 3.3% on the day. The fund has a Zacks ETF Rank #3 (Hold) with a High risk outlook.

SPDR S&P Bank ETF (NYSEARCA:KBE) also has similar holdings; but it holds stocks in an equal-weighted manner. No stock accounts for more than 2.75% of the fund and diversifies stock-specific risks pretty well. Though KBE has a Zacks ETF Rank #2 (Buy) with a High risk outlook, it shed 3% on February 2.

SPDR S&P Regional Banking ETF (NYSEARCA:KRE) takes into account companies that do business as regional banks or thrifts. KRE was down 3.1% on the day, though it has Zacks ETF Rank #2 with a High risk outlook.

iShares MSCI Europe Financials ETF (NASDAQ:EUFN) measures the combined equity market performance of the financial sector of developed market countries in Europe. Since UBS holds 3.8% of the fund, the product was down about 4% on February 2. The fund has a Zacks ETF Rank #3.

SPDR S&P Capital Markets ETF (NYSEARCA:KCE) also lost a considerable 4.33% on February 2 as it invests 3.04% of its assets in Goldman. KCE has a Zacks ETF Rank #3.

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