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Choosing the Best Option for Your Financials

July 24, 2019

Rotation into Financials and other more cyclical areas of the market is a popular theme among many of the top Technicians that we follow right now. When we dove into Financials we noticed an interesting divergence between its two largest Sector ETFs, $XLF and $IYF. In early July the iShares US Financials ETF, IYF broke out to fresh all-time highs. XLF did not.

This strength in IYF may surprise some people as the popular benchmark Financial Sector SPDR ETF, XLF has been an underperformer relative to other Large Cap Sectors for years and is still trapped beneath its key 2018 highs.

Many believe this month's new highs in the major US Equity Indices indicate the beginning of a new cyclical bull market. Considering the iShares US Financials chart resembles the price action of the broader market and the ETF represents a wide range of stocks in its sector, this could also signal the start of a fresh bull market in Financials. This would be an environment in which XLF would likely make new highs as well. It's currently less than 7% and 10% off its 2018 and 2007 highs, respectively.

The underperformance from XLF relative to IYF is nothing new as there is a similar divergence in price over the long-term. Not only has XLF failed to confirm the recent new high in IYF but when IYF made fresh post-Financial Crisis highs in January of 2018 XLF failed to reclaim its all-time highs from 2007. As you can see in the chart below, XLF has yet to make new highs while IYF has been chopping above and below its 2007 record highs since January of last year and just resolved back above these levels to fresh all-time highs this month.

IYF has outperformed XLF by roughly 50% since its inception almost 20-years ago. So, what is driving this long-term outperformance? From taking a quick glance at the ETFs components, I'd say the following two factors are the primary reasons.

  1. IYF has a combined 10% exposure to two of the top-performing Large Cap Financial stocks over the past decade, Visa ($V) and Mastercard ($MA), while XLF has no exposure to these companies because they are classified in the Technology sector. Visa is up roughly 1,275% since its IPO just over a decade ago while Mastercard is up a cool 6,325% since its 2006 debut.
  2. The big 4 banks, JP Morgan ($JPM), Bank of America ($BAC), Wells Fargo ($WFC) and Citigroup ($C) comprise 30% of XLF vs only 17% of IYF. The big banks have been laggards since the early 2000s, particularly on a relative basis.

Some other differences in the ETFs construction worth noting are that the iShares US Financials ETF has a 20% allocation to small and mid-caps as well as a 20% allocation to Real Estate while XLF is invested purely in the Financial space and has just a 5% exposure to mid-caps. IYF is also invested in a broader variety of stocks with 284 components compared to just 69 for XLF.

The bottom line is that IYF's chart looks a lot more like leading Financial subsectors such as Broker-Dealers & Exchanges ($IAI) and Insurance ($IAK), consolidating above its key 2007 highs, while XLF looks a lot more like the lagging Banks ($KBE) and Regional Banks ($KRE) subsectors which are still trapped below these key levels. If you're going to put money to work in Financials at the sector level, this should be enough evidence to suggest that the iShares US Financials ETF is the best way to express that thesis.

Hope you enjoyed this post! As always, reach out to me at Strazza@thechartreport.com with any questions or comments.