Bank stocks took a tumble this year in the wake of deposit runs that resulted in several U.S. banks being placed into receivership with the Federal Deposit Insurance Corp.
But that banking crisis did not spread through the industry, and now, several months later, the sector seems to have stabilized. This is not to suggest that the near-term outlook won't be challenging. But at this point, contrarian investors may be thinking about increasing their exposure to the banking sector while valuations and stock prices within it remain depressed.
But this can also be a daunting proposition because the sector does face challenges, and share prices could continue to be volatile, especially with second-quarter earnings season starting. The good news is that you don't have to pick a winner in the banking sector to get exposure.
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Picking winners is hard
There's risk in almost any stock you can buy, which is why most investing experts preach the virtues of diversification. The banking sector has endured some hardship this year as rising interest rates pushed their bond investments underwater, deposits at some institutions fled, and deposit and other funding costs rose.
The yield curve has also been inverted for many months now, which is problematic for banks that typically borrow money short at low rates and lend it out long at higher rates. Furthermore, many banks are expecting more stringent regulatory requirements. And let's not forget about post-pandemic credit normalization because loan losses are expected to rise, particularly in areas like commercial real estate.
The combination of these challenges only adds to the difficulty of picking a good bank stock to invest in. In addition, bank stocks can sell off as a group if just a few experience extreme problems (as occurred earlier this year), and there still could be surprises lurking.
That's why if you think investors have overreacted to this year's banking industry issues, the best way to play the sector might be through an exchange-traded fund (ETF). An ETF holds a basket of stocks, but it trades on an exchange like an individual stock. They tend to be less volatile than a single stock, and offer a good way to get exposure to an entire sector.
An ETF would be a great choice right now because it would increase your banking sector exposure, but still provide protection if one or two banks run into more severe issues. One good option is the SPDR S&P Regional Banking ETF (KRE -1.24%), which has a portfolio largely comprised of regional banks.
Data source: YCharts.
After selling off by nearly 26% so far this year, the SPDR S&P Regional Banking ETF is trading near the lows it touched during the early months of the pandemic, when it looked like much of the economy could shut down for months at a time.
Some of the top holdings in the KRE are bank stocks that I think are poised to perform well, among them New York Community Bancorp, Cullen/Frost Bankers, Regions Financial, and Webster Financial.
Play the long game
To state the obvious, banks face a challenging near-term outlook. But truthfully, as a group bank stocks can be excellent investments to own for long-term wealth creation and passive income.
Banks have also shown that they are usually resilient even in troubled times, and I do believe the sector will ultimately rebound. By putting money in the SPDR S&P Regional Banking ETF, investors can get exposure to a sector trading at an attractive valuation while largely avoiding the risks of any specific institution's failure.
