The Fed stress test could be the final capital raise for big banks, unless the economy deteriorates substantially further, says Associate Director of Research Matt Warren. - Morningstar (Target $14.4) Morningstar introduction and analysis The Financial Select Sector SPDR XLF offers investors relatively cheap exposure to the currently out-of-favor financial-services sector. The holdings of this exchange-traded fund are squarely in the cross hairs of the destruction caused by the collapsing domestic housing market, which has wreaked havoc on the financial system via bad loan exposure and deflating asset prices. At this point, we think that overweighting one's financial exposure through a position in this fund represents a high-risk/high-reward investment scenario. Investors should note that adding this ETF to a portfolio that already contains a broad market index, such as the SPDRs SPY, essentially represents "double-dipping" in the sector; this ETF represents the 13% financial-sector weighting in the S&P 500. In our opinion, investors should also be aware that investing in financial-services firms' common equity requires a certain degree of faith, given the changing dynamics and the government's ever-growing and immensely influential role in the industry. As we learned in 2008, if the government is forced to take action, there's a strong likelihood that common equity holders in a given institution get left out to dry while those holding the debt (and in some cases preferred securities) are made whole. We don't make this point so that investors avoid this ETF (or the common equity of financial institutions, in general). However, we think that it is prudent for investors to not only understand their investments but also to be cognizant of the significant risks that may abound. The game has changed in the financial sector. The banking business model is quickly evolving to resemble that of a regulated utility (that is, stringent oversight and lackluster top-line growth). Simply put, the days of being wildly overleveraged to take on outsized risks without adequate compensation are clearly behind us.
$12.08 (05/26/09)
