Investors are fleeing the financials at the highest rate in years

Financial stocks have been a bit of a puzzle.

Investors may think that with a central bank on a firm tightening path, industry deregulation efforts in play and high expectations for banks' growth heading into this year, financial firms would be thriving.

But they're badly lagging the market, and fund flows paint an ugly picture.

During the four weeks ending Friday, the XLF, the S&P 500 financial sector ETF, has seen the largest outflows in three years. The financials have fallen more than 4 percent while the S&P 500 has risen a bit more than 1 percent in that time. Investors have pulled roughly $2.5 billion out of financials ETFs in the last month.

Why the mass exodus?

First, the Federal Reserve chose to raise interest rates in the most recent FOMC meeting earlier this month. This is normally a bullish sign for financials as it tends to signal a healthier economy and traditionally causes the shorter end of the yield curve to rise.

But at the same time, policy uncertainty and trade tariffs have placed the market on edge, causing the longer end of the yield curve to fall by almost as much as the short end has risen. This negatively impacts banks' net interest margins, or the difference between the shorter- and longer-dated rates.

Net margins have been steadily falling since the end of 2016 as the Fed has steadily raised rates, but the so-called longer end of the yield curve has been skeptical of future growth.

Our view is that we are on a dangerous path with this trade war. It could knock off as much as 0.3 percent to 0.4 percent off of gross domestic product growth in the U.S. by 2020, according to Oxford Economics estimates, so we agree with the caution here.

Ultimately, stay away from financials until the net interest margin stabilizes.

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Michael Santoli

Michael Santoli joined CNBC in October 2015 as a Senior Markets Commentator, based at the network's Global Headquarters in Englewood Cliffs, N.J.  Santoli brings his extensive markets expertise to CNBC's Business Day programming, with a regular appearance on CNBC's Closing Bell (M-F, 3PM-5PM ET). In addition, he contributes to CNBC and CNBC PRO, writing regular articles and creating original digital videos.

Previously, Santoli was a Senior Columnist at Yahoo Finance, where he wrote analysis and commentary on the stock market, corporate news and the economy. He also appeared on Yahoo Finance video programs, where he offered insights on the most important business stories of the day, and was a regular contributor to CNBC and other networks.

Follow Michael Santoli on Twitter @michaelsantoli

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