XLF Financial Select Sector

With recovering housing fundamentals and increasing consumer confidence, the U.S. mortgage finance industry has made a comeback with improving credit quality and declining delinquencies.
 
Improving Trends
 
The Mortgage delinquency rate (U.S. homeowners that are behind on their mortgage payments) dropped to 4.09% in the third quarter from 5.33% in the year-ago period and 4.32% in the second quarter. This represents the lowest level in five years (read: 3 Homebuilder ETFs Leading the Pack this Earnings Season).
 
Though the delinquency rate is still above the pre-housing bubble levels, TransUnion expects mortgage delinquency rate to fall to below 4% by this year-end.
 
The declining delinquency rates coupled with increasing credit balance in turn enhances credit quality of the firms, making the conditions ideal for investing in the mortgage finance industry. Further, stable job markets, rising home sales, higher home prices and still-low mortgage interest rates are compelling homeowners to finance more loans.
 
Both 30-year and 15-year mortgage rates retreated to 4.22% and 3.27%, respectively, from their highs of 4.58% and 3.60%, reached in August.
 
Fed Policy Fuels Further Strength
 
At the latest FOMC meeting, the Fed announced that it could curtail the massive asset-purchase program at one of its next few meetings if economic growth warrants a QE reduction (read: Mortgage REIT ETFs in Focus on Renewed Taper Concerns).    
 
However, the Fed is seeking to keep interest rates near the zero level even if tapering starts until unemployment hits 6.5% and inflation stays under 2.5%. The low borrowing cost would continue to propel mortgage financing growth as more buyers opt for new financing.
 
How to Play?
 
Investors interested to play the current surge in the space in ETF form might consider the SPDR S&P Mortgage Finance ETF (KME). The ETF gained more than 5% over the past 10 trading sessions, clearly outpacing the gains of 1.89% for the broad market fund (SPY) and 3.14% for the broad financial sector fund (XLF). The fund is up about 31% in the year-to-date time frame.
 
We think KME could be poised for a further surge in the coming months, based on both technical and fundamental factors described below (read: Top Ranked Financial ETF in Focus: VFH):
 
Technical Look
 
The fund currently hit its new high of $55.32 and its short-term moving average (9-Day SMA) is comfortably above the longer-term averages (50 and 200-Day SMA), suggesting continued bullishness for this ETF.
 
This is further confirmed by an upswing in the Parabolic SAR, although this figure should definitely be monitored closely (see all the Financial ETFs here).
 

 
Fundamentals
 
The fund provides diversified exposure within the broader mortgage finance industry by tracking the S&P Mortgage Finance Select Industry Index (read: Financial ETFs in Focus on Earnings).
 
Currently, the product is under-appreciated and overlooked by many investors as indicated by its AUM of only $8.2 million and average daily trading volume of just under 2,000 shares. The product charges 35 bps in fees and expenses.
 
Holding 55 securities in its basket, the product is well spread out across various securities as none of these accounts for more than 2.49% of total assets. Robust performance from the components in the fund’s holdings like Assured Guaranty (AGO), Old Republic International (ORI), Bofi Holdings (BOFI) and The Hanover Insurance Group (THG) and their surging stock prices helped KME to hold up strongly.
 
Within the broad industry, more than half of the portfolio is tilted toward property and casualty insurance companies while the other half goes to thrifts & mortgage finance and homebuilding. At time of writing, five out of six Zacks industries that are classified under mortgage finance have Zacks Ranks in the top 35%, suggesting more upside potential in the coming months.
 
Further, the fund has a great Zacks ETF Rank of 2 or ‘Buy’ rating and is thus expected to outperform in the months ahead (read: all the Top Ranked ETFs).
 
Bottom Line
 
Based on the solid industry outlook as well as the bright fundamentals, the ETF looks worthwhile for investors seeking to ride out the strong recovery in the mortgage financial space. 
 
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ASSURED GUARNTY (AGO): Free Stock Analysis Report
 
BOFI HLDG INC (BOFI): Free Stock Analysis Report
 
SPDR-KBW MTGE (KME): ETF Research Reports
 
OLD REP INTL (ORI): Free Stock Analysis Report
 
HANOVER INSURAN (THG): Free Stock Analysis Report
 
SPDR-FINL SELS (XLF): ETF Research Reports
 
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