Janus Capital’s Bill Gross issued his monthly investment outlook this morning (here) with a specific focus on financial stocks, particularly banks. Not surprisingly, Gross is cautious on the sector. He feels that monetary policy that have worked in the past to stimulate growth:
via a wealth effect and its trickle-down effect on the real economy, negative investment rates and the expansion of central bank balance sheets via quantitative easing are creating negative effects
And this is where he turns his sights on bank stocks:
Negative yields threaten bank profit margins as yield curves flatten worldwide and bank NIM’s (net interest rate margins) narrow. The recent collapse in worldwide bank stock prices can be explained not so much by potential defaults in the energy/commodity complex, as by investor recognition that banks are now not only being more tightly regulated, but that future ROE’s will be much akin to a utility stock.
He concludes:
Do not reach for the tantalizing apple of high yield or the low price/ book ratio of bank stocks. Those prices are where they are because of low/negative interest rates.
There is more in there so read it for yourself. But for the most part it reinforces my view that in the near term the bull case for banks, even here in the U.S. and no matter how well capitalized relative to pre-crisis levels or how cheap they are, adequately reflect the challenges to future earnings and sales growth.
A few weeks ago, when JPM was trading $57.30 I expressed a near term bearish view into April expiration with outright puts (read here), this was after their CEO’s infamous open market purchase of 500,000 shares below $54. Two weeks later after the company’s investor day, and the stock down 5% I spread these puts (read here), reducing my premium at risk, while also reducing potential profits on a pullback. I tried to be careful on the short side on with stocks or sectors that have shown good relative strength since the market topped last year, but of late have found it irresistible to short sectors like materials (XLB), staples (XLP) and retail (XRT) that have simply had mean reversion trades after horrible 2015 performance.
Bank stocks are a bit different though. They were acting very well right up until the last tick of 2015, but as soon as contagion concerns spread from Europe and emerging markets in early January causing the Fed to hold off on interest rate increases, it was lights out for the banks. While concerns of some sort of credit/commodity contagion has clearly abated since Feb 11th it’s still important to focus on JPM’s commentary that sent their shares down 7% in two days following their investor day. That is the Fed’s guidance for banks to consider a negative interest rate environment for the upcoming stress tests and then of course Q1 earnings in April.
Looking at the XLF as a proxy for bank stocks, five of the top 10 holdings, equaling nearly 30% of its weight, with BAC, C, JPM, USB & WFC all reporting before April expiration on the 15th.
Short dated options prices in the XLF have come in fairly dramatically of late, with 30 day at the money implied volatility at 21.5%, well below the 35% in mid February, but not far above the 1 year average of about 19%:
[caption id="attachment_61883" align="aligncenter" width="600"]
From Bloomberg[/caption]
The one year chart of the XLF shows the etf’s 13% bounce off of its Feb 1tth low, out-performing the gains of the S&P500 (SPX) during the same period of about 9.5%. This makes some sense given how hard hit most of the stocks were at the lows, many down more than 20% on the year:
[caption id="attachment_61884" align="aligncenter" width="600"]
From Bloomberg[/caption]
The chart also shows the etf at prior support, which is now resistance. If the it does not fail here I suspect it continues back to its 150 day moving average just above $23.
Given the rally in the markets, the recent out-performance of this sector on no news, relatively low levels of implied volatility, upcoming central bank meetings (ECB March 10, BOJ March 15 & FOMC March 16), upcoming Fed stress test results and obviously Q1 earnings in April, I think the sector sets up for a re-test of the Feb lows in the coming weeks.
So what’s the Trade?
The jobs report tomorrow could give an opportunity for an entry a bit higher if we see that on the open. We’d look to buy near the money puts a few months out (likely May) and give some time for the thesis to play out. But we’d also like to finance those trades, perhaps with some nearer term lower strike puts on weakness.
Stay tuned.