Under the Spotlight Wall St: Financial Select Sector SPDR Fund (XLF)

U.S. bank stocks have bolted out of the gate in 2025 and have taken the S&P 500 Index higher on strong earnings growth, optimism about President Trump’s economic policies and hopes for lighter regulation.

State Street’s Financial Select Sector SPDR Fund ($XLF) is a popular ETF choice among investors wanting a diversified portfolio spread across big banks like JPMorgan Chase ($JPM), Bank of America ($BAC) and Goldman Sachs ($GS). But it invests in more than just banks, holding stakes in credit card providers like MasterCard ($MA) and Visa ($V) as well as insurers. Its top holding is actually Warren Buffett’s Berkshire Hathaway ($BRK.B). More on that later.

$XLF has tracked the S&P 500 Index’s financial stocks since its inception in 1998. It’s one of the largest sector ETFs, with around US$51b in assets under management, and is among the most traded ETFs on a daily basis. It pays quarterly distributions and its gross expense ratio is 0.09%. $XLF is up 33% over the past year compared to 25% for the S&P 500 Index. 

Cash machines

The latest round of quarterly earnings showed that lower U.S. interest rates didn’t stop the largest banks from reaping a profits bonanza. The six big banks – JPMorgan, Bank of America, Wells Fargo ($WFC), Citigroup ($C), Goldman Sachs and Morgan Stanley ($MS) – lifted their collective annual profits from US$122b in 2023 to US$145b in 2024. 

Investment banking helped drive higher profits as mergers and acquisitions picked up pace. The associated fees at JPMorgan, Bank of America, Citigroup, Goldman Sachs and Morgan Stanley rose from US$24b in 2023 to US$33b in 2024. Goldman Sachs topped the M&A league table in value of deals, while JPMorgan secured the biggest share of investment banking revenue. M&A is expected to get even hotter in 2025, as strong markets have lifted the share prices of potential acquirers, providing firepower to make deals. Many large companies have significant cash on their balance sheets. The removal of election uncertainty should also boost investor confidence.  

Trading revenues were strong too, as investors adjusted portfolios based on the shifting outlook for inflation, interest rates, the U.S. election and geopolitical risk. JPMorgan’s Q4 markets revenue rose 21% year-on-year to US$7b due to higher revenues across credit, currencies, emerging markets, derivatives and cash equities. Citigroup’s Q4 trading revenue rose 36%, with fixed income trading up 37% to US$3.5b. Volatility is a trader’s friend, and with Trump back in the White House, it’s likely there will be plenty more to come.

Credit cards featured in retail banking earnings – and not for the right reasons. Investors will need to closely watch the strength of the American consumer. As U.S. households strain under elevated interest rates and cost-of-living pressures, they resort to credit cards more. And so JPMorgan Chase, the largest credit issuer, saw Q4 card and auto service revenue increase 14% to US$6.9b. The problem is their card services net charge-off rate (the proportion of debt unlikely to be paid back) increased from 2.79% in Q4 2023 to 3.30% in Q4 2024. Bank of America reported Q4 consumer net charge-offs of US$1.1b on ‘seasonally higher credit card losses.’ Citigroup’s 90-day-plus delinquency rate on branded credit cards moved higher in 2024. 

Endgame

Donald Trump’s second term in the White House is expected to deliver lighter bank regulations to free up capital and drive investment, economic growth and earnings. The path seems clear: the Federal Reserve’s vice chair for supervision stood down in early January to avoid becoming a ‘distraction’ after drawing criticism for wanting tougher bank regulations. This allows Trump to appoint someone who aligns with his deregulation agenda. Fed governor Michelle Bowman, who has advocated a ‘pragmatic’ approach, is viewed as a leading candidate. 

Top of the wish list will be a watering down of what’s known in the arcane world of global bank regulation as Basel III Endgame. U.S. banks were able to lower a proposed increase in capital from 19% to 9%, but will be lobbying to push that down further. Another capital drain in the crosshairs is a surcharge on Global Systemically Important Banks, or G-SIBs. The central role U.S. banks play in global finance puts them in higher risk ‘buckets’. JPMorgan, as the world’s largest listed bank, sits alone in bucket four and is required to have an additional 2.5% capital buffer. Citigroup is in bucket three and must set aside 2%. U.S. banks have US$230b in total set aside for G-SIB capital buffers. 

The supplementary leverage ratio is another regulation that is likely to come under the spotlight. The SLR forces banks to hold capital against their investments despite the risk level of those investments. Banks have complained the capital constraint restricts them from buying U.S. government bonds. With U.S. debt growing quickly – and treasuries issuance climbing – it would seem like a win-win outcome for banks and the Treasury if the SLR was modified. Banks will continue to push the Fed on its annual stress tests. They’ve even sued the Fed for greater transparency. 

Bite-sized Buffett

$XLF offers a way to gain exposure to Warren Buffet’s Berkshire Hathaway without investing US$700,000 in a Class A share, or US$460 for Class B. Berkshire represents 12.1% of the portfolio. 

The Oracle of Omaha is most widely recognised as a respected value investor who’s built a formidable record over many decades. But that’s only part of the story: Berkshire is a giant of the global insurance industry through its ownership of brands such as GEICO and Homestate. According to insurance credit ratings agency AM Best, Berkshire Hathaway is the second largest insurer in the world based on net non-bank assets, and the ninth largest based on net premiums written. It is also the world’s second largest reinsurer, or an insurer which provides insurance to other insurers. Rival Swiss Re sees ‘above trend growth’ in insurance industry premiums over 2025 and 2026. 

It’s worth noting Berkshire Hathway’s stock portfolio contains substantial investments in $XLF’s top holdings. Berkshire owns Bank of America and American Express ($AXP). The portfolio also holds Coca-Cola ($KO), Kraft Heinz ($KHC) and Apple ($AAPL).  

Net interest

Banks enter 2025 with strong earnings momentum. Hopes are high that the Trump administration will deliver stronger economic growth. This would boost the confidence of borrowers and deal makers, and ultimately, bankers’ bottom lines. 

Lighter bank regulation looms as a potential tailwind for $XLF in 2025. So too does the hefty weighting of Berkshire Hathaway and Warren Buffett’s track record as the ultimate risk manager.

This is not financial advice nor a recommendation to invest in the securities listed. The information presented is intended to be of a factual nature only. Past performance is not a reliable indicator of future performance. As always, do your own research and consider seeking financial, legal and taxation advice before investing.