3 Financial ETFs To Avoid During Q2 Bank Earnings

David Dierking

The Q2 earnings season is kicking off in earnest this week. The results are expected to be bad pretty much across the board, but the damage will be especially bad in the financial sector.

Banks have already suffered from record low interest rates, which have squeezed profit margins, despite continued demand for mortgages. Since the coronavirus started spreading like wildfire, the economic environment for banks has gotten even worse.

With unemployment shooting through the roof, it's estimated that nearly 1/3 of mortgage holders failed to make their July monthly payment. If tiny margins on existing loans were bad enough, a significant chunk of your loan customer base effectively defaulting on their obligations is even worse.

Bank stocks and ETFs have already been punished as traders recognize the inherent risks and struggles of the financial sector. Much of that is already priced into bank stocks, but there's a lot of downside risk still present.

With many companies failing to provide forward guidance in light of the COVID outbreak, we truly don't know what to expect. Low expectations could still be wildly optimistic. Dividend cuts could be on the way too.

Wells Fargo led the way on Tuesday with far-below-expectations results in Q2 and an 80% cut in its dividend. And there could be more to come.

I'd avoid the financial sector altogether until the Q2 earnings season winds down and we have a better idea of how the banks are positioned as we enter the 2nd half of 2020.

In particular, here are three major bank-heavy ETFs to avoid.

Financial Select Sector SPDR ETF (XLF)

XLF is easily the largest financial ETF in the marketplace with more than $15 billion in assets right now. It spreads its investments across the entire space, meaning it includes insurance companies, asset managers and the like too. But banks account for more than 30% of its assets.

JPMorgan Chase, Bank of America, Citigroup and Wells Fargo are four of the fund's top 5 holdings (Berkshire Hathaway is the other).

Vanguard Financials ETF (VFH)

This fund is very similar to XLF, but it has a heavier weighting in the banking sector, coming in between 30-40% overall.

VFH has nearly 2/3 of the fund's assets committed to the combination of the banking and capital markets sectors, which will be heavily impacted this quarter.

Invesco KBW Bank ETF (KBWB)

This is perhaps the most bank-exposed ETF in the marketplace. Whereas funds, such as XLF and VFH, focus on the entire financial services sector, KBWB is almost entirely invested in just the banks.

More than 80% of assets are invested in large and regional banks of all sizes.

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