Some investors are embracing the financial sector ahead of what they deem as an even more euphoric stretch of a new roaring 20s, whereas others believe a recession is imminent. The most direct way to bet on that sentiment would be to bet on something like the Fidelity MSCI Financials Index ETF (NYSEARCA:FNCL).
Financials are the backbone of everything in this economy. These companies are the ones lending, processing, and investing in every other sector. If the financial sector starts losing steam or catches fire, a recession is all but guaranteed.
On the other hand, if these companies stay solid or even keep doing well, it’s going to boost the broader economy.
But again, the choices you have aren’t strictly binary. Let’s take a look at what you can and should do with the FNCL ETF. First, let’s dig into what it does.
A mix of banks, asset managers, and everything finance
FNCL tracks the MSCI USA IMI Financials Index, giving you broad exposure to U.S. financial stocks across the entire market-cap spectrum. The largest holding is JPMorgan Chase (NYSE:JPM | JPM Price Prediction) at 10.1%, followed by Berkshire Hathaway (NYSE:BRK.B) 7.7%. After those two, you have the two biggest payment processors everyone knows, followed by a lot more banks.
The first five holdings constitute 33.79% and are likely meant to be an anchor for the rest of the ETF. Financials are different, so diversification within the sector doesn’t always mean more safety due to most of the companies being alike.
Thus, allocating more to some of the safest names isn’t a bad idea. In a banking crisis, I’d expect customers to park more money in JPMorgan, with Berkshire declining less than the broader market due to its $400 billion cash pile.
A very underwhelming record
The financial sector is rather risky, and we saw a shaky period play out in early 2023 when the Federal Reserve had to step in. Since higher risk means higher returns, you’d expect FNCL to get you markedly higher returns compared to the broader market. Unfortunately, this is not the case.
The FNCL is up 37% in the past five years, and it is up a measly 4.4% in the past year. You don’t even get a good dividend yield to make up for it, at 1.67%. The expense ratio is 0.08%, which I think is one of the few good things here.
Considering you are not getting good returns and you’re still taking on a lot of risk, especially with the AI debt “bubble” many analysts are discussing, why are people still buying this?
How FNCL can redeem itself
FNCL’s inception was in 2013, so you don’t have a multi-decade history to go off of. That said, this ETF did keep up with the S&P 500 in the early to mid-2010s when interest rates were super low. Banks do make less money when you have higher interest rates, but lower interest rates boost the whole financial sector overall.
Hence, the bull case for this FNCL would unfold if you get interest rate cuts, plus successful returns on investments in AI.
You’re going against the grain by betting that AI will eventually generate so much value and productivity that we might even live in a world of deflation. This is what OpenAI’s Sam Altman is arguing. I could certainly see the financial sector delivering explosive gains in this case.
Should you buy or sell FNCL now?
I’m all-in on the sell camp when it comes to this ETF. You need an AI utopia for this ETF to outperform the broader market and compensate you for the risk you are taking today. And even if this happens, you probably would’ve made more money by buying AI companies instead of financials.
We are currently seeing an uptick in inflation, with the latest report coming in higher than expected at 3.8%. I do not see interest rate cuts kicking in anytime soon. The rapid interest rates needed to meaningfully lift this ETF could only come from a recession, which would crush these financial stocks.
If you are thinking about buying FNCL for diversification’s sake, I would refrain from doing that, either. You are better off buying consumer staples because the financial sector will never be the green outlier during a broad-based downturn.
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