Fed Reverses QE: Financial ETFs & Stocks To Buy

As expected, the Fed kept the short-term interest rates steady at 1-1.25% in its two-day FOMC meeting concluded yesterday and laid out the timing of reverse quantitative easing (QE), starting next month.

The central bank will start unwinding its $4.5-trillion balance sheet, which is mostly composed of Treasuries and mortgage-backed securities it acquired under a program known as QE till 2014 since recession. So long, it has reinvested the entire proceeds it got from bonds. Now, the Fed will use a cap system every month to execute its roll off plans and reinvest the rest.

The central bank has set a roll off target of $10 billion ($6 billion in Treasuries and $4 billion in mortgage-backed securities) per month that will increase every quarter until it reaches $50 billion ($30 billion for Treasuries and $20 billion for mortgage-backed securities) a month. The process is likely to continue until the balance sheet reaches about $2-$2.5 trillion.

The Fed also hinted at one more rate hike this year and expects three lift-offs in 2018. According to the CME Group's FedWatch tool, the odds for a rate hike by December increased substantially to 67% from 58% a day ago.

The move gave a bit more hawkish-than-expected signal, pushing Treasury yields higher, and in turn benefiting the financial sector. The sector is a major beneficiary of a rising-interest-rates environment. This is because the steepening yield curve would bolster profits for banks, insurance companies, discount brokerage firms and asset managers.

Further, the upside to the finance sector is confirmed by the Zacks Sector Rank in the top 50% with more than 70% of the industries placed in the top 38%. This suggests continued outperformance for the sector for the coming months. That said, Zacks Financial Leasing Companies topped the list followed by Zacks Foreign Banks and Zacks Life Insurance.

Accordingly, we have highlighted four ETFs and stocks that are expected to see smooth trading for the rest for the year and lead the market higher.

Top ETFs

While there are a number of ETFs in this corner of the market, we have highlighted those that have a solid Zacks ETF Rank #2 (Buy) and offer broad exposure to the sector.

Financial Select Sector SPDR Fund (XLF - Free Report)

This is by far the most-popular financial ETF in the space with AUM of $25.6 billion and average daily volume of nearly 68.2 million shares. The fund follows the Financial Select Sector Index, holding 69 stocks in its basket with double-digit allocation to the top two firms, Berkshire Hathaway Inc. (BRK-B - Free Report) and JPMorgan Chase & Co (JPM - Free Report) . In terms of industrial exposure, banks take the top spot at 44% while capital markets, insurance and diversified financial services make up for a double-digit exposure each. The fund charges 14 bps in annual fees and is up 10.5% in the year-to-date time frame.

Vanguard Financials ETF (VFH - Free Report)

This fund manages nearly $6.2 billion in asset base and provides exposure to a basket of 412 stocks by tracking the MSCI US Investable Market Financials 25/50 Index. It is pretty well spread with each holding less than 9% of assets. Banks account for nearly half of the portfolio, followed by insurance (21%) and financial services (11%). The product sees solid volume of 783,000 shares and charges 10 bps in annual fees. It has gained 9% since the start of the year.

iShares U.S. Financial Services ETF (IYG - Free Report)

This product follows the Dow Jones U.S. Financial Services Index, holding 116 securities in its basket with concentration on the top three firms — JPM, Bank Of America (BAC - Free Report) and Wells Fargo (WFC - Free Report) — that collectively make up for 29% of assets. Banks take the top spot at 55.8% from the sector look while diversified financials and software & service make up for the remainder. IYG has amassed $1.3 billion in its asset base and trades in a good average daily volume of about 175,000 shares. It charges an annual fee of 44 bps from investors and has gained 11.5% so far this year.

First Trust Financials AlphaDEX Fund (FXO - Free Report)

This fund follows the StrataQuant Financials Index, which uses the AlphaDEX methodology to select stocks from the Russell 1000 Index and ranks them on both growth and value factors. The approach results in a basket of 183 securities, which are widely spread across components, with none holding more than 1.11% of assets. In terms of industrial exposure, insurance takes the top spot with 23.3% share, while capital markets, REITs, banks and IT services round off the next spots. The fund has accumulated nearly $1.1 billion in AUM and sees a good trading volume of about 285,000 shares a day. It charges 64 bps in fees per year and is up 8.9% this year.

Top Stocks

We have chosen three stocks using the Zacks Stock Screener that fits our criteria of a Zacks Rank #1 (Strong Buy) or 2 (Buy), and Growth Style Score of A or B.

AerCap Holdings N.V. (AER - Free Report)

This Zacks Rank #2 integrated global aviation company is engaged in the lease, financing, sale, and management of commercial aircraft and engines in China, the United States, Ireland, and internationally. The stock has seen solid earnings estimate revision of 46 cents over the past 90 days for this year and has delivered positive earnings surprise of 15.68% in the past four quarters. It has a VGM Style Score of B.

HSBC Holdings plc (HSBC - Free Report)

This Zacks Rank #1 company with a VGM Style Score of B is one of the largest banking and financial services organizations in the world. It saw positive earnings estimate revision of 21 cents over the past 90 days for this year, with a whopping growth rate of 212.18%.

First Bancorp (FBP - Free Report)

This Zacks Rank #2 holding company for FirstBank Puerto Rico with a VGM Style Score of B provides a range of financial products and services to retail, commercial and institutional clients. The stock saw positive earnings estimate revision of three cents over the past 90 days for this year with a growth rate of 10.47%.

Evercore Inc. (EVR - Free Report)

This Zacks Rank #2 investment banking company provides advisory services to multinational corporations on mergers, acquisitions, divestiture, restructuring and other corporate transactions. It saw positive earnings estimate revision of 26 cents over the past 90 days for this year with a growth rate of 21.76%. It has a VGM Style Score of A.

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