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Stalled Financials Offer a Bit of Value

The financial-services sector has underperformed in 2014 and still faces headwinds, but the Financial Select Sector SPDR ETF also looks relatively undervalued.

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Bob Goldsborough: The U.S. financial-services sector has lagged the broader U.S. equity markets since the start of 2014. And while this sector has enjoyed a tremendous comeback since the bottom of the financial crisis, the sector has stalled out a bit since the start of 2014.

While this sector is not incredibly inexpensive right now, it does trade at a relative discount to other U.S. equity sectors. Year to date, the financial-services sector has returned about 2% in aggregate relative to the approximately 5% in aggregate that the S&P 500 Index has returned.

Large banks dominate the U.S. financial-services sector. And while banks are in much better shape than they were heading into the financial crisis, banks recently received a jolt when the U.S. Federal Reserve's recent stress test of the U.S.'s 30 largest banks showed some areas of concern.

In response to this, banks have been facing higher legal and compliance costs as they try to get their regulatory and compliance areas in line with what federal regulators are looking for. In addition, banks also are struggling with low interest-spread revenue, which doesn't look like it's going to go up anytime soon.

One large, liquid, and low-cost exchange-traded fund devoted to the financial-services sector is Financial Select Sector SPDR. It offers broad exposure to the financials sector and is market-cap weighted, which means that larger names such as Wells Fargo, Berkshire Hathaway, and JPMorgan Chase hold larger positions and carry more sway. The fund trades at 97% of Morningstar's equity analysts estimate of fair value, which means it trades at a slight discount to the broader U.S. equity market.

In an environment where U.S. equities are largely fairly valued, this fund represents an opportunity for investors to buy into a sector that is relatively undervalued.

Robert Goldsborough does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.