Fear An Inverted Yield Curve? Short Financial Stocks With ETFs

Financial stocks have been going through a rough patch with Financial Select Sector SPDR ETF (NYSE:XLF) XLF and SPDR S&P Bank (NYSE:KBE) ETF KBE losing about 4.9% and 8.9%, respectively, in the past week. The outcome of the latest Fed meeting which saw cuts in economic growth projections and benign rate outlook weighed on financial stocks.

Further, global growth apprehensions emanating from slowdown in Euro zone and China as well as Brexit issues marred the risk-on sentiments. Investors should note that manufacturing new orders in Germany dropped to the lowest level (40.1) since the financial crisis.

Inside the Moderation of U.S. Economic Forecast

Investors should note that, in March, the Fed lowered forecast for 2019 real GDP growth to 2.1% from December’s projection of 2.3%. Notably, the projected figure was 2.5% in September. The central bank trimmed the 2020 growth forecast to 1.9% from 2.0% in December. However, the central bank maintained projections for 2021, which calls for economic growth of 1.8%.

PCE inflation expectations for 2019 were lowered to 1.8% from 1.9% (projected in December). Federal funds rate projections for 2019 were trimmed to 2.4% from 2.9% while the same for 2020 and 2021 was cut to 2.6% from 3.1%. For the longer term, the rate is projected at 2.8%, same as projected in December (read: Go Long on Rate Sensitive Sectors With These ETFs).

Labor market projections have also been bearish with unemployment rates trending upward for each year. Rates were raised from 3.5% in December to 3.7% for 2019, from 3.6% to 3.8% for 2020 and from 3.8% to 3.9% for 2021.

Inverted Yield Curve

All these sparked a safe-haven rally and led the benchmark 10-year U.S. Treasury yield to drop to a 15-month low. The benchmark U.S. treasury yield was 2.44% on Mar 22, down 10 bps from the day before.

According to Refinitiv Tradeweb data, the spread between the three-month Treasury bill and the 10-year note rate turned negative — though temporarily — for the first time since 2007, per a CNBC article.

This kind of flattening yield curve is negative for financial stocks. Since banks borrow money at short-term rates and lend capital at long-term rates, a lower long-term rate does not bode well. If the yield curve flattens, net interest rate margins of banks decline. This clearly explains the underperformance of banks or overall financial ETFs. Investors withdrew about $440 million of assets from XLF past week, per etf.com.

Inverse Financial ETFs

Given the prevailing bearish outlook, the appeal for financial ETFs, especially banks, is dull for the near term. As a result, investors who are bearish on the sector now may want to consider a near-term short. There are several inverse financial ETFs to play this kind of a flattening yield curve scenario. Below we highlight a few of them.

ProShares Short Financials ETF SEF

This fund provides unleveraged inverse (or opposite) exposure to the daily performance of the Dow Jones U.S. Financials Index. The ETF makes a profit when the financial stocks decline and is suitable for hedging purposes against the fall of these stocks. The fund is up 3.2% past week (as of Mar 22, 2019).

ProShares UltraShort Financials ETF (AX:SKF)

This fund seeks two times (2x) leveraged inverse exposure to the Dow Jones U.S. Financials Index. The fund has advanced about 7.0% past week.

ProShares UltraPro Short Financial Select Sector ETF (BS:FINZ)

Investors having a more bearish view and higher risk appetite may find FINZ interesting as the fund provides three times (3x) inverse exposure to the S&P Financial Select Sector Index. It has surged 14.4% in the past five days.

Direxion Daily Financial Bear 3x Shares ETF FAZ

This product provides three times inverse exposure to the Russell 1000 Financial Services Index. The fund has gained 9.3% past week.

Direxion Daily Regional Banks Bear 3x Shares WDRW

This fund seeks to deliver thrice the inverse return of the S&P Regional Banks Select Industry Index. The fund is up about 32% in the past week (read: 5 Best Inverse Leveraged ETF Areas of 2018).

Bottom Line

As a caveat, investors should note that such products are suitable only for short-term traders as these are rebalanced on a daily basis. Still, for ETF investors who are bearish on the financial sector for the near term, either of the above products could make an interesting choice (see: all the Inverse Equity ETFs here).

Want key ETF info delivered straight to your inbox?

Zacks’ free Fund Newsletter will brief you on top news and analysis, as well as top-performing ETFs, each week. Get it free >>