With the yield curve finally starting to normalize again, the financial sector is finally looking better than it has in many months. I don't think that means you should just jump in anywhere though. Certain segments are more attractive than others. Large and regional banks probably play best. Insurance companies not so much.
But one area I'm seeing a lot of interest in is the high yielders. And I just don't get it.
The Invesco KBW High Dividend Yield Financial ETF (KBWD) is a fund that I've seen highlighted in three separate articles in just a little over a week. I get that both the S&P 500 and most Treasury maturities are offering no more than 1.8% and investors are scouring for higher yields anywhere they can find them, but KBWD just isn't the place they should be shopping.
The Bull Case
I sort of get where some investors are coming from. The strong GDP number, the low unemployment rate and strong consumer spending have some feeling like recession risk is off the table for the time being.
The Fed has already dropped rates three times recently and I imagine they'll do so again at least once and probably twice in 2020. Lower rates on the short end, courtesy of the Fed, and higher rates on the long end, courtesy of a still healthy economy, steepens the yield curve making profitability for banks much easier.
Treasury Bond Yields Should Start Dropping
I believe that long-dated Treasury yields will start heading back down again. The underlying fundamental data for this economy clearly show that a slowdown is real and things are in much more of a fragile state than the latest Dow level will have you believe.
The early Q4 GDP estimate is currently at just 0.4%. Industrial production is still contracting. The trade war continues to cut into corporate profitability and consumer spending.
If rates resume their decline and the Fed starts dropping the Fed Funds rate back towards zero again, bet that banks and real estate will soon follow.
KBWD Is All Financials And REITs
And those are the two areas that KBWD is loaded up on. Not just that, the focus on high yielders steers the portfolio away from the biggest and sturdiest companies and towards the more speculative names.
The half of the portfolio dedicated to REITs is almost entirely mortgage rates. If the economy begins to slow significantly and the demand for real estate and mortgages declines, KBWD could be heading downhill quickly.
But even in better economic conditions, KBWD didn't perform that well.
The fund trails the S&P 500 Financials Index, the primary benchmark it measures itself against, by more than 4% annually since its inception in 2010. That's nearly a decade of significant underperformance.
Year-to-date, KBWD is trailing the bank and real estate sectors by an extraordinary 16%.
How To Play This In Your Portfolio
High yielders will always be riskier by nature but the risk of KBWD hasn't paid off in any way, shape or form. Yield seekers should search elsewhere unless you're interested in trying to time the mortgage REIT sector.
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