4 Reasons Why Bank ETFs Have More Room To Rally

As of March 25, 2021, the 10-year benchmark U.S. treasury yield was 1.63% versus 14 bps of the 2-year treasury yield. Meanwhile, the 10-year treasury yield was 1.45% at the start of the month versus 13 bps of the 2-year treasury yield. This led to a rise in yield spread by 17 bps this month, resulting in a steepening yield curve.

As banks seek to borrow money at short-term rates and lend at long-term rates in a steepening yield curve environment, banks will earn more on lending and pay less on deposits, thereby leading to a wider spread. This expands net margins and increases banks’ profits.

Undervaluation

Bargain hunting could also lead to some gains in bank stocks. The forward P/E of Banks - Major Regional is now 13.16X versus 21.27X of the S&P 500. Financial - Investment Bank has a forward P/E of 13.59X, Financial - Savings and Loan has a forward P/E of 13.49X, Financial - Consumer Loans has a forward P/E of 9.63X, Financial - Investment Management has a P/E of 11.68X, and Financial - SBIC & Commercial Industry has a P/E of 10.74X. Such numbers point to the broad-based undervaluation of the banking sector and some room to rally.

Earnings Growth Potential

As of now, the Zacks Earnings Trend predicts a 75.9% rise in Q2 earnings and 0.9% expansion in revenues from financial services companies. If the virus crisis is tackled carefully (which may require much caution given the global rises in COVID-19 cases), a 2020-like crisis will likely be avoided in 2021.

Global vaccination has started, which should provide some support to the ongoing health crisis, even if there is a rise in cases. Hence, bank ETFs may register decent gains in the medium-term on moderate economic growth.

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