Financials Could Feel The Heat

By Kevin Grewal

Although the future of reform legislation remains unclear, a recent bill proposed by Senator Christopher Dodd could potentially hinder the financial sector and its exchange traded funds (ETFs).

This new proposed reform, which is expected to be forced onto the Senate Finance Committee as early as next week, aims to give the Federal Reserve extraordinary control and power over large financial institutions.   More specifically, it would give the Fed the power to break up any large financial institution which could potentially jeopardize the stability of the financial system. 

Additionally, the bill will give the Fed authority and control over the nation’s largest bank-holding companies, those with assets of $50 billion or more, and be the focal point of oversight and regulation over mortgage-related businesses and non-bank financial firms like insurance companies.  The bill specifically aims to regulate risky financial instruments, like mortgage-backed securities. 

Another caveat of the bill includes Federal Deposit Insurance Corporation (FDIC) oversight over state-chartered banks with less than $50 billion in assets.

Lastly, the bill is expected to contain an arm which will enable the Fed to curb proprietary trading at banks and bank sponsorships of hedge funds and private equity funds.  In and of itself, if this proposed bill makes it passed bank lobbyists and Republicans, it could potentially hinder profits of these firms.

Some equities that would be influenced by this bill include:

• the Financial Select Sector SPDR (XLF), which boasts Bank of America (BAC) and JP Morgan Chase (JPM) as its top holdings, both of which are the nation’s top holding companies.  XLF closed at $15.54 on Monday.
• the iShares Dow Jones US Financial Services (IYG), which boasts Wells Fargo (WFC) and Citigroup.  IYG  closed at $57.72 on Monday.
• the iShares Dow Jones US Broker-Dealers (IAI), which boasts Goldman Sachs (GS) and Morgan Stanley (MS) as top holdings and closed at $28.40 on Monday.
• the iShares Dow Jones US Insurance (IAK), which holds companies like Prudential Financial (PRU) and Aflac Inc. (AFL).  IAK closed at $29.25 on Monday.

In addition to the forces that this bill may bring on to the financial sector, when investing in the sector it is equally important to keep in mind the inherent risks that are involved.  To help mitigate these risks, the implementation of an exit strategy which triggers price points at which an upward trend could potentially be coming to an end is of importance.

According to the latest data at www.SmartStops.net, an upward trend in the mentioned ETFs could come to an end at the following price points: XLF at $14.94; IYG at $55.53; IAI at $27.48; IAK at $28.04.  These price points change on a daily basis as market conditions fluctuate and updated data can be found at www.SmartStops.net.