(Bloomberg) -- When Federal Reserve Chairman Jerome Powell spoke to Congress for the first time last week, investors sent cash flooding into an exchange-traded fund focused on banks and other financials.
The Vanguard Financials ETF, ticker VFH, saw $235 million in inflows last week -- the most received in any single week on record for the fund -- as Powell spoke about the strength of the U.S. economy and the outlook for inflation. His comments raised the possibility that the Fed could speed up its timeline for three interest rate hikes this year, or even add a fourth to the mix. And finance firms are one part of the market that could get a boost from that.
“Banks will benefit from a rising interest rate environment,” said Gary Bradshaw, a portfolio manager at Hodges Capital Management in Dallas.
“They're able to loan out money at higher rates and then what they pay on the deposit doesn't go up as much,” he added. “Their net interest margins improve pretty dramatically, which is a big boost to banks' earnings.”
Clearly some people didn't see that logic as bank stocks lagged last week. The S&P 500 financials index fell 2.3 percent over the five days, more than the S&P 500's 2 percent decline. To Bradshaw, the underperformance is a short-term move, indicative of the sector's connection to 10-year Treasury yields, which ended last week at 2.86 percent after nearing the psychological 3 percent threshold a week prior.
“As those rates go higher, those stocks are going to go up, and as they come back down, they'll selloff,” he said. “But folks are anticipating rates to go higher this year, so they're making the bet on the financials.”
In fact, of the 10 largest U.S. listed financial ETFs, nine have taken in cash this year. The Financial Select Sector SPDR Fund, ticker XLF, is the only one that's seen outflows, with investors yanking more than $600 million from the fund in 2018.
Buyers may be pouring cash into the Vanguard fund for a cheaper play, according to Josh Lukeman, head of ETF market making in the Americas at Credit Suisse. XLF charges $1.30 for every $1,000 invested, while VFH charges $1, according to Bloomberg data.
“The VFH trade could be more of the cost war we've seen, although it's only 3 basis points,” Lukeman said. “But might be enough to make the case versus XLF.”
To contact the reporters on this story: Sarah Ponczek in New York at sponczek2@bloomberg.net, Carolina Wilson in New York City at cwilson166@bloomberg.net.
To contact the editors responsible for this story: Jeremy Herron at jherron8@bloomberg.net, Eric J. Weiner, Rachel Evans
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