XLF Financial Select Sector

The financial sector, which accounts for around one-fifth of the S&P 500 index, had an outstanding 2013.  An improved asset market and sound balance sheet primarily helped the sector regain its ground lost five years bank in recession. However, things faltered at the start of this year as evident from the not-so-encouraging first quarter earnings results from the major banking organizations.

Industry dynamics for banking and brokerage concerns seems to have weakened of late thanks to lackluster activities both at household and corporate levels, high frequency trading concerns, increased regulatory scrutiny and sluggish mortgage as well as capital market business.

As per Zacks Industry Trends, the financial sector was to fall 3.9% on bottom line in Q1 with the slide being sharp (down 6.8%) for major banks. Banks and Thrifts and Insurance will likely deteriorate about 15% in the quarter being reported. Sequentially, earnings growth will likely exhibit a flat trend for the major banks and remain down for Insurance and Investment Brokers/Managers (read: Broker Dealer ETF (IAI) in Focus on High Frequency Trading).  

Amid such a scenario, some top banks like JP Morgan, Goldman Sachs, Bank of America reported last week. Let’s delve a little deeper into the big banks’ Q1 earnings and see how things are shaping up for the sector:

Big Bank Earnings in Detail

JP Morgan (JPM) kicked off the season with sagging numbers after booking solid earnings in the last quarter. Its earnings of $1.28 per share fell short of the Zacks Consensus Estimate of $1.41 and deteriorated from the year-ago number of $1.59. Net revenue of $23.9 billion was down 8% from the year-ago quarter and was also below the consensus estimate of $24.6 billion.
 
Bank of America (BAC) too had a flop in Q1. It reported a loss of $0.05 per share against earnings of $0.10 in the year-ago quarter and missed the Zacks Consensus Estimate of earnings of $0.05. However, its fully taxable-equivalent revenues (net of interest expense) fell 4% to $22.7 billion which was higher than the Zacks Consensus Estimate of $22.5 billion (read: Can Bank ETFs Bounce Back After Recent Downgrade?).
 
However, there are some dark horses in this otherwise pale banking sector. Wells Fargo earned $1.05 in 1Q14, marking the seventeenth consecutive quarter of earnings per share growth. Results improved from $0.92 per share earned in the year-ago quarter.
 
The reported figure bettered the Zacks Consensus Estimate by $0.08 per share. The quarter’s total revenue came in at $20.6 billion, outpacing the Zacks Consensus Estimate of $20.5 billion. However, revenues were down 3.3% year over year.

Citigroup (C) also emerged a winner in this quarter erasing its some of its past failures.  Its earnings of $1.30 per share outpaced the Zacks Consensus Estimate of $1.18 and improved a penny from the prior-year earnings. Revenues dropped 1% year over year to $20.12 billion but surpassed the Zacks Consensus Estimate.

Goldman Sachs (GS) earned $4.02 per share in the first quarter, down from the year-ago earnings of $4.29, but ahead of the Zacks Consensus Estimate of $3.43. Net revenue declined 8% year over year to $9.3 billion, but outpaced the Zacks Consensus Estimate of $8.9 billion. Though by a slight margin, shares were in the green in immediate trading after the earnings release.  

Morgan Stanley (MS) continued its positive surprise streak, delivering another beat in this quarter and posting $0.68 per share of adjusted earnings. Net revenue went up 4% year-over-year to $8.8 billion and outpaced the Zacks Consensus Estimate of $8.6 billion. Morgan Stanley gained 2.91% following the earnings release.

ETF Impact

All the aforementioned companies have considerable exposure in funds like iShares U.S. Financial Services ETF (IYG), PowerShares KBW Bank (KBWB), Market Vectors Bank and Brokerage ETF (RKH), Financial Select Sector SPDR (XLF), U.S. Broker-Dealers Index Fund (IAI) and Vanguard Financials ETF (VFH) (see all the financial ETFs here).
 
All these ETFs gained as four out of six baking giants put up a relatively better show. IAI added the most (4.34%) last week while the S&P 500 index gained about 1.89%.  RKH, IYG, XLF, VH returned about 2.33%, 1.87%, 1.91%, 1.66%, respectively. KBWB, however, nudged up 0.68%. Excessive focus on the laggards like J P Morgan and Bank of America might have restricted KBWB from generating more returns.

What Lies Ahead?

We would like to note that the inertia in JP Morgan and Bank of America was something anticipated and investors should not be bogged down by this fact as others had a decent Q1. Also, with the passage of harsh winter which restricted consumer activity, the sector should see some tailwinds.

Morgan Stanley already noticed month-on-month loan growth in March after two successive fragile months and believes consumer balance sheets will likely pickup momentum through Q2. In fact, earnings growth for the financial sector should resume from Q3.

Overall, the sector has a positive undercurrent as evident from the clearance of the Fed’s stress test by major banks. As many as 29 out of the 30 banks passed the Fed test, hinting at enough capital that big banks presently have to endure harsh losses during a crisis situation.

Also, financial institutions, which are more into the broker-dealer/capital markets segment, might get their share of aid next year once the Fed fully wraps up its bond buying program (read: 3 Financial ETFs to Play the Bank Stress Tests).

Bottom Line

While a single stock pick is always an option, a basket approach can also be considered to minimize risk and bet on the best of the financial spectrum. And to do this, investors can consider the aforementioned financial ETFs almost all of which are top rated.

XLF and IAI carry a Zacks ETF Rank of 1 or Strong Buy rating with a high risk outlook. VFH and IYG carry a Zacks ETF Rank of 2 or Buy rating with a high risk outlook while KBWB has a 2 rank with a medium risk outlook. Only RKH presently has a Zacks ETF Rank of 3 (Hold rating) with a medium risk outlook, so it appears as though most financial ETFs are looking strong as we head further into Q2.

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BANK OF AMER CP (BAC): Free Stock Analysis Report
 
CITIGROUP INC (C): Free Stock Analysis Report
 
ISHARS-US BR-D (IAI): ETF Research Reports
 
ISHARS-US FN SV (IYG): ETF Research Reports
 
JPMORGAN CHASE (JPM): Free Stock Analysis Report
 
PWRSH-KBW BP (KBWB): ETF Research Reports
 
MKT VEC-BANK&BR (RKH): ETF Research Reports
 
SPDR-FINL SELS (XLF): ETF Research Reports
 
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