Bank ETFs: Value Play or Value Trap?

Wall Street has been witnessing excessive gyrations for the past few days, thanks to the red-hot inflation and rising rate worries. The S&P 500 has seen an 8.8% decline in the past one month (as of Sep 21, 2022). Bank ETF SPDR S&P Bank ETF KBE has lost7% in the past month. Investors should note that bank ETFs are cheap as KBE has a P/E ratio of 11.30X while SPDR S&P 500 ETF Trust SPY has a P/E ratio of 21.70X.

Now, the question is, is this a value play or a value trap?

Are Banks in Trouble?

While bank stocks and ETFs offer value, there are some glitches. Since banks borrow money at short-term rates and lend capital at long-term rates, steepening of the yield curve bodes well for bank stocks and ETFs.

But we have been facing a flattening of the yield curve lately. The benchmark treasury yield slumped to 3.51% on Sep 21 from the day before, while the two-year treasury yield jumped to 4.02% from 3.96%. This has resulted in a flattening of the yield curve.

The Federal Reserve hiked benchmark interest rates by another 75 bps and indicated that it would keep hiking well above the current level to tame sky-high inflation. Fed officials signaled the intention of continuing to hike until the funds level hits a “terminal rate,” or endpoint, of 4.6% in 2023, per a CNBC article. That implies a quarter-point rate hike next year but no decreases.

The median Federal Funds rates are now projected to be 4.4% for 2022 (from 3.4% projected in June). For 2023 and 2024, the same is projected to be 4.6% (from 3.8% in June) and 3.9% (from 3.4% in 2024).

The Fed also hiked its inflation forecast for the year. The central bank now expects the median inflation rate to jump to 5.4% this year, higher than its previous forecast of 5.2%. PCE inflation expectation has gone up to 2.8% for 2023 from 2.6% projected in June.

The Fed downgraded its forecast for 2022 median real GDP growth from 1.7% in June to 0.2% for 2022. It lowered the growth rate expectations for 2023 and 2024 to 1.2% and 1.7% from 1.7% and 1.9%, respectively.

But if there is more fear in the market, safe-haven trade may keep the long-term yields extremely low, resulting in a continued flattening of the yield curve and hurting banks further. There is also the concern that amid economic slowdown, there could be a rise in delinquency rates, affecting banks’ asset quality.

The growing risk of a global recession owing to the rising rate worries will likely hurt demand for high-quality loans too, which will cause trouble for the banking sector. With activities likely to be shrinking, demand for loans from household and corporations is likely to drop.

Any Silver Lining?

Having said all, we would like to note that banks still have cheaper valuations. Invesco KBW Bank ETF KBWB, SPDR S&P Bank ETF KBE and First Trust Nasdaq Bank ETF FTXO currently have a P/E ratio of 12.64X, 11.30X and 10.85X, respectively. If there is any improvement in risk-on sentiments, banks are likely to bounce back sharply.

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SPDR S&P 500 ETF (SPY): ETF Research Reports
 
SPDR S&P Bank ETF (KBE): ETF Research Reports
 
Invesco KBW Bank ETF (KBWB): ETF Research Reports
 
First Trust NASDAQ Bank ETF (FTXO): ETF Research Reports
 
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