exchange traded funds
severely lagged the market the past five years but it appears
they've overtaken the market this year thanks to rising interest
They stand to benefit most from rising long-term interest
rates because such action widens their net interest margin, or
the difference between the short-term interest rates at which
they borrow and the long-term interest rates at which they
The Federal Reserve has pledged to hold down short-term
interest rates near zero until
hits 2% and the unemployment falls below 6.5%, which could
"But long-term rates can move higher because the markets
expect more economic growth a year or so from now," said Paul
Edelstein, director of financial economics at IHS, based in
Rising mortgage rates and home values may jolt potential
homebuyers to act now before rates rise further, thereby boosting
demand for home loans.
In addition, when rates are rising, people, instead of putting
their money in higher risk assets such as stocks, tend to save
more thereby boosting bank deposits, says Tim Dyer, vice
president of Sage Capital Advisors in La Jolla, Calif., with $150
million in assets under management.
"The bank expands its balance sheets and in turn relends that
money at an attractive spread," Dyer said in an email. "This can
drive earnings higher and ultimately the underlying share
"Bank credit, while recovering, is rising at a slow and
measured pace," Bank of America Merrill Lynch investing
strategists wrote in a report June 6. "(BofA Merrill) data show
that mortgage credit for housing purchases or refinancing has
improved in the past 18 months, but from a very low base."
SPDR KBW Regional Banking ETF (
), the largest of its kind by assets, holds 78 equal-weighted
stocks. It's returned 17% year to date and 26% in the past 12
months vs. 15% and 23% for SPDR S&P 500 (
). This marks a notable turnaround after lagging the market the
past three years. KRE rose an average annual 12% over three
years, while SPY averaged 16%.
IShares Dow Jones U.S.Regional Banks (
) holds 60 cap-weighted stocks. It most heavily weightsUS Bancorp
) at 21% of assets,PNC Financial Services (
) 12% andBB&T (BBT) 7%. IAT gained 17% year to date and 25%
in 12 months.
PowerShares KBW Regional Banking Portfolio (KBWR) holds 50
stocks. Its largest holding,Susquehanna Bancshares (SUSQ),
accounts for 4% of assets. The laggard among the three, KBWR is
up 15% year to date and 20% in one year.
IAT trades at a discount compared with its peers and the
market. It trades at nearly 13 times forward earnings and 1.2
times book value. The S&P 500 trades at a forward P/E of 15
and 2 times book value.
But banks and the broader financial sector as tracked bySPDR
Financial Select Sector (XLF) still trade deep below their
prebear market highs, suggesting they have more upside potential
to "catch up" with the market.
A major risk is that new regulations from the Dodd-Frank Act
in the next three years could squeeze banks' profits as they have
to spend more time and money on compliance, says Bill Hammer, CEO
in Melville, N.Y. He recommends individual investors limit
exposure to any individual sector ETF to 5% of their