Financial Stock ETFs Look Downright Dangerous. How To Manage the Risk.

Every major market decline includes financial stocks melting down. I do not know if this is a threat or a reality. But the charts have me on guard with regard to this key market sector. After all, if the financial system is in disrepair, it is like a car with a faulty engine. Let’s take a look under the hood of S&P 500 Financials Sector SPDR (XLF), the biggest exchange-traded fund (ETF) devoted to stocks in the U.S. financial sector.

The technical chart is vulnerable at best and on the verge of collapse at worst. That PPO indicator at the bottom is akin to grasping at straws, and getting few in the hand each time. The save here could be the $50 to $51 level, as that has been bounce territory multiple times before. XLF is a good example of how technical analysis is often less of a buy-sell system, and more a warning-alert system. Each investor does their own thing with that information.

My ROAR score is an extension of that, since I created it to essentially do the chart reading for me, automatically. In the case of XLF, it has been in red (high risk to return) territory for a while. And as you can see in the lower portion of the picture just below, the ETF’s price is starting to realize that higher-risk signal and head lower.

At nearly 18x earnings, financial stocks would be cheap. If they were tech stocks. But for financials, the biggest portion of many value portfolios, there’s no screaming value here.

The Bull and Bear Cases

The bull case for XLF rests on the improving structural environment for large-cap banks and investment firms. Proponents highlight that the Federal Reserve is projected to continue cutting interest rates throughout 2026, which historically helps steepen the yield curve and expand net interest margins. 

There is also a significant expectation for a rebound in capital markets activity. Several high-profile private companies are planning initial public offerings (IPOs) this year, which could drive a surge in investment banking fees for the dominant holdings in the fund. Furthermore, the insurance segment, which makes up about 14% of the portfolio, remains a solid defensive anchor with stable earnings power, regardless of short-term market fluctuations.

The bear case is focused on the mounting risks within the credit markets and the potential for a weakening labor market to impact consumer finance. Strategists have expressed concern about rising problem loans and the fragility of regional banking balance sheets, which could spill over into the larger institutions.

There is also a notable bearish sentiment reflected in the options market, where the put to call volume ratio for XLF has recently spiked to over 4x. This suggests that professional traders are aggressively hedging against a further decline. Critics also point out that if hotter than expected inflation forces the Fed to pause its rate-cutting cycle, the anticipated relief for bank margins may fail to materialize, leaving the sector vulnerable to a valuation reset.

This ETF relies on its top holdings. The 10 biggest make up more than half of XLF. That means keeping an eye on the top handful is the key to assessing the sector as a whole. Follow the leaders.

The key turnaround potential here is either technical, as noted above, or a radical change in interest rates that steepens the yield curve. To me, those are not base-case scenarios. So I’m viewing XLF very cautiously.

Rob Isbitts created the ROAR Score, based on his 40+ years of technical analysis experience. ROAR helps DIY investors manage risk and create their own portfolios. For Rob's written research, check out ETFYourself.com.