ETF Investing: Financial ETFs could extend rally

By John Spence, MarketWatch
BOSTON (MarketWatch) — Exchange-traded funds that invest in
financial shares have jumped almost 10% so far this month, raising
hopes the lagging sector will perk up and be a catalyst that extends
the stock-market rally into 2011.

Although the bounce in the broad market since the beginning of
September has been impressive, bank shares were noticeably absent from
the party until last week's strong showing.

!! Debt Markets Defy Fed\'s Stimulus !!
Jon Hilsenrath discusses why the Fed's new stimulus efforts have
failed to lower long-term interest rates in the six weeks since the
plan was officially begun.

The lack of participation from the financial sector has been troubling
for bulls, especially since early weakness in bank stocks in 2007 was
a harbinger of the crash.

The rally over the past three months has pushed the S&P 500 Index
 to a
new 52-week high, yet unloved financial stocks have climbed only about
halfway back to the peak from April.

The Financial Select Sector SPDR Fund
, with assets approaching $7 billion, is off to a strong
start this month partly on expectations more banks may reinstate or
raise dividend payments.

Meanwhile, the Treasury Department is taking steps to exit its
ownership stakes in bailed-out financial giants Citigroup Inc.
 and American International Group Inc.
 as the companies try to escape government involvement in
management and capital decisions.

!! Banking On Growth!!
"More than two years after the financial crisis, we believe the U.S.
financial services sector is poised to shift toward capital deployment
from capital accumulation in 2011," analysts at Keefe, Bruyette &
Woods said in a sector outlook.

"In our view, capital redeployment will focus on increased
dividends, share repurchases, and mergers and acquisitions," they
wrote, while cautioning that lending and growth for financials will be
"constrained by the slow pace of the U.S. economic recovery."

Signs of improvement in the recent economic data are likely fueling
bank stocks, although the November jobs report was much weaker than
expected as the unemployment rate rose to 9.8%.

The financial sector is also facing new regulations and capital
requirements after the credit collapse, while another leg down in
housing prices is among the risks for banks.

Some money managers say the banking bailout simply papered over bad
loans and kicked the can down the road.

"Banks went into the 2008 credit crisis loaded with toxic assets,
and, to a large extent, they still have them," said Comstock
Partners Inc. in a Dec. 9 market commentary. "This is one of the
reasons banks are hoarding cash and are so reluctant to lend."

Speaking a a Goldman Sachs financial conference last week, Bank of
America Corp.
 Chief Executive Brian Moynihan said he
sees a slow grind for the economy over the next few quarters.

"We're going to have a long-term, steady recovery from this
recession as best we can see," the CEO said, according to a
transcript provided by FactSet CallStreet. "But I wouldn't expect
to see loan growth streaming ahead largely due to fact that we're
all careful on the risk right now and the economy is just not there to
really support it."

B. of A. shares are emblematic of the weakness in the financial sector
despite the stock's roughly 15% rise in December. The banking
giant's stock has trended steadily lower since the May "flash
crash" and is actually below where it started September, while the
broader market has rallied.

!!Breakout Plan!!
As a group, financial stocks are trying to break the trading range
they've been stuck in since the flash crash. Last week's rally
took the sector right to the highs from November and it may be poised
for a breakout.





The sharp rise in long-term interest rates has put some fire into bank
stocks as the so-called yield curve steepens, analysts say. Banks see
higher profits on loans when short-term rates are lower than long-term

Buying interest in regional-bank stocks has been primarily stoked by a
steepening of the yield curve as the yield on the 10-year Treasury
note spiked above 3% last week, according to J.P. Morgan analysts.

"In our view, this response in valuations is justified given that a
steeper yield curve should support net interest income growth as cash
and securities are potentially invested at higher rates," they wrote
in a Dec. 10 note to clients. "The steeper curve also points to
growing probability for rising short-term rates, which is a
potentially powerful catalyst for core-deposit-funded

Banks raising dividends could also make the sector more attractive to
income-oriented investors, particularly if the 15% tax rate on
qualified dividends is extended.

Many ETFs invest in banks, as do financial subsector funds for real
estate firms and broker-dealers. SPDR KBW Bank ETF
, for example, is the largest bank fund by assets.
MarketWatch ETF screener.

John Spence is a reporter for MarketWatch in Boston.
Source: Marketwatch.Com