Interest Rates and the Financial Sector
The Financial sector, as represented by the S&P 500 Financial sector ETF (XLF), has consistently outperformed its peers, returning 26.65% on a year-to-date basis. The YTD performance is nearly double that of the S&P 500 Index (13.29%). Financials have been rallying strongly due to the rising US interest rates. However, the US yield curve spread has begun to contract. For instance, the 10-year minus the 2-year yield and the 10-year minus the 3-month yield spread is narrowing. The other maturities, such as the 30-year, 10-year, and 5-year, have broken down, near-term as yields contracted and declined.
If the trend continues, this will put pressure on the earnings of many of the financial names, including banks. However, if this a near-term correction and yields and their spreads resume their widening trend, financial stocks will resume their primary uptrends.
So, will the financial sector and the banking sector begin to cool off as the yield curve contract and interest rates fall, or is this only temporary?
The S&P 500 Financial sector is currently 11.63% of the overall market weightings of the SPX Index, behind Information Technology (26.53%), Healthcare (13.06%), Consumer Discretionary (12.02%). As can be expected, financial stocks tend to outperform during the early parts of an economic recovery/expansion cycle. Financials tend to give up leadership and begin to slow as the business cycle moves toward mid-cycle, where Information Technology and Communication Services excel.
The Financial sector contains seven key industries: Banking, Capital Markets, Consumer Finance, Diversified Financial Services, Insurance, Mortgage REIT, and Thrifts and Mortgage Finance. Banking remains an influential subindustry of the financial sector, accounting for over 52% of the total market-cap weight.
Although the intermediate-to-longer term trends are still favorable, the large-cap Bank ETF (KBE) is beginning to show technical signs of weakening. The violation of the Feb 2021 uptrend and the 50-day ma at 53-54 warns of a near-term correction. Crucial support is 49-50, coinciding with the Mar/Apr 2021 lows. Below this, suggests a retest of 44-45 or the 38.2% retracement from Sep 2020-Mar 2021 rally and the 200-day ma. Trading above 56.16-55.73 (Mar/Jun 2021 highs) confirms a technical breakout and signals the resumption of the primary uptrend.
The three large bank stocks (i.e., JPM, BAC, and C) still retain their respective intermediate-to-long term uptrends. However, with the yield curve contracting and interest rates slipping, the above three banking giants may soon test pivotal supports, corresponding to their respective 50-day moving averages, near-term uptrends, and retracements.