Investors Just Flooded Into Financials at the Fastest Weekly Pace Ever

Nearly $5 billion in inflows to the most popular financial ETF.

Options Insight: How to Bank on Financials

In the week following the election, the Financial Select Sector SPDR exchange-traded fund amassed $4.9 billion of inflows — a record, and more than it accumulated in the past three years.

XLF US Equity (Financial Select  2016-11-16 10-23-14
Source: Bloomberg

This ETF has stakes in major U.S. financial institutions, including banking behemoths like JPMorgan Chase & Co. and Citigroup Inc.

President-elect Donald Trump's victory has spurred a steepening of the yield curve fueled by rising term and inflation premiums, as investors move to price-in both his fiscal policies and the vast amount of uncertainty surrounding them.

Yield-curve steepening is conducive to an improvement in banks' net interest margins, and therefore a boon for profitability.  

Financial deregulation also looks to be on the agenda in a Trump administration, though the extent to which there's a desire to "dismantle" the Dodd-Frank Act remains unclear.

"This is a sign of both the Trump-inspired bullishness for the sector as well as the increase in the size and number of investors using ETFs to express opinions," said Eric Balchunas, an analyst of exchange-traded funds at Bloomberg Intelligence. "This is what it looks like when hot money gets excited. Keep in mind these flows could come out just as easily if the narrative changes again."

XLF is up 11 percent in the five sessions through Tuesday, its first weekly stretch of double-digit gains since October 2011. 

There are some signs this advance may have run a bit too far, too fast. The gap between two- and ten-year Treasury yields that is expected to benefit financial intermediaries was over 50 basis points larger in the middle of 2015 — but XLF was more than 10 percent below where it is today.

"Flows into XLF are mainly performance chasing after this rally," said David Schawel, portfolio manager at New River Investments. "Financials are indeed asset sensitive and will earn more money when rates rise, but the rally looks to have gotten ahead of itself based on the relationship between rates and price to tangible book values."

It also remains to be seen whether the new administration pursues protectionist trade measures that foster restrictions on the free flow of capital and could reduce U.S. banks' opportunities to make profits.

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