The bad news keeps piling up for JPMorgan Chase (NYSE:JPM), and so does the uncertainty. The bank was hit by two shareholder lawsuits Wednesday over its surprise $2 billion-and-counting trading loss. The Securities & Exchange Commission is having a look and, more ominously, so is the Justice Department. Even if it all comes to nothing, headlines about the FBI taking a preliminary poke into the bank’s business doesn’t exactly instill confidence.
True, the sell-off in JPMorgan in wake of the bombshell news could be an opportunity to buy shares in the nation’s biggest bank on the cheap. Then again, as they say on Wall Street, there’s never just one cockroach, so there’s nothing wrong with investors in the financial sector feeling like they should perhaps play some defense in the face of all this uncertainty.
Not only is the news flow going against the bank, but the bad trade that clobbered it is still on the books. The firm’s position is so large that it will take time to unwind. Another $1 billion in losses is possible through year end, the bank said, and some reports say the total could balloon to $4 billion.
That isn’t nearly enough to kill the bank. JPMorgan is expected to earn more than $17 billion in profit this year, and has its self-proclaimed Fortress Balance Sheet. In the parlance of the Street, this is not a “capital event.” JPM is safe, as are its dividend and share-repurchase program.
But as CEO Jamie Dimon said, the bad trade could lead to earnings volatility over the course of the year. That could very well extend to share-price volatility, too.
Financial sector bets have come down hard lately, with the JPMorgan news only adding fuel to extant anxiety over the European debt crisis. But the financials are still handily beating the broader market, and if you’re bullish on stocks, you have to like financials, too. It’s hard to see how the market could enjoy sustained gains without the financials participating.
To that end, exchange-traded funds offer broad, diversified exposure to the financial sector — but some are more tied to JPMorgan than others. As the nation’s second-biggest bank by market cap after Wells Fargo (NYSE:WFC), JPM has a heavy weighting in the popular large-cap financial ETFs.
For example, if you’re looking to reduce risk to JPMorgan and any knock-on effects on the other big banks, you might want to stay away from the Financial Select Sector SPDR ETF (NYSE:XLF). JPMorgan is the third-largest holding, with a weighting of 7.8%, according to data from Morningstar. Citigroup (NYSE:C) and Bank of America (NYSE:BAC) are also in the top five, and they’ll probably move in sympathy with JPMorgan’s stock if more cockroaches do indeed come scurrying out.
The iShares Dow Jones US Financial Sector ETF (NYSE:IYF) also counts JPMorgan, Citigroup and BofA as top holdings. However, with 256 names, it’s far more diversified than XLF, which is more concentrated with just 81 positions. In addition to banks, IYF holds insurance companies, credit card companies and real estate investment trusts. That help makes the IYF less volatile than XLF. Then again, they pretty much move in lockstep.
For a broad, diversified play on both large and regional banks, the SPDR S&P Bank ETF (NYSE:KBE) holds 38 names ranging from Wells Fargo to Valley National Bancorp (NYSE:VLY). No Wall Street titans show up in this ETF. Neither do insurance companies, credit card companies or REITS. KBE has held up better than XLF since the JPMorgan news broke, although it’s trailing the broader IYF.
Finally, if you just want to hide out in small regional banks, there’s an ETF for that too — the SPDR S&P Regional Bank ETF (NYSE:KRE). But be forewarned that the sector has plenty of its own issues. The housing, manufacturing and commercial lending markets vary across different regions of the country, meaning these banks face a whole different set of headwinds. That said, KRE has held up best among these ETFs. It’s off less than 3% since the JPMorgan news broke, while JPMorgan itself is down a very painful 9%.
As of this writing, Dan Burrows doesn’t hold a position in any securities mentioned here.