I’ll keep this fairly simple. This morning’s weak May jobs data, and sharp revision lower to what was already a poor April print takes a June rate increase off of the table. A weak June print will make a July hike extremely unlikely, and then your guess is as good as mine for September, but there is no way in hell the Fed will hike at their November 2nd meeting, days before the presidential election. So if it’s a no go this Summer, I think the chance for multiple hikes in 2016 becomes severely challenged. If that is in fact the case (none, or one and done) then U.S. Treasury yields continue to track their long term downtrend, and likely re-test their recent all time lows near 1.5%, and probably make a new low.
While this may sounds nuts, the narrowing spread between 2 and 10 year treasuries at 93 bps suggests that our economy is not exactly as strong as the Fed would like in order to continue to tighten monetary policy.
The hardest hit sector today is banks stocks, which had been rallying of late on the potential for rate hikes. A steepening yield curve is the only way in the near term these companies will grow revenues on increasing net interest margins.
To get a sense for where our sovereign debt maybe going, and how our bank stocks may act if in fact yields go lower, look no further than the European Bank Stock Index (SX7E), which is down about 38% from its 52 week highs, and only up about 13% from its 52 week and nearly 4 year lows.
This index is a slow moving trainwreck. Why, you ask? Well, it’s a little thing called no growth in the Eurozone combined with the fact that trillions of dollars of their sovereign debt has a negative yield, with the worldwide total recently topping $10 trillion. I suspect this price action bleeds over to the U.S. as the prospects for anything more than a ceremonial 2016 rate increase fade.
I want to focus on what I perceive to be the worst of the large U.S. moneycenter banks, Citigroup (C). At its morning lows today, shares of C were down 5.6%. They have since come back a bit, down about 3.5% this afternoon, but the stock is still down about 12.5% on the year, and down 25% from its 52 week highs made last Summer. The one year chart shows the well defined downtrend:
Taking a slightly longer term view, $45, appears to be a fairly important multi-year support level, and when it finally broke it in January, the stock went straight to $35:
EPS and sales are expected to decline 11% and 7% respectively, and just yesterday at an investment conference, Citi CEO Corbat said (via Reuters):
Q2 net income “roughly flat” for Q1 for entire company, expects Q2 trading revs. to be “slightly up” vs. Q1.
Consensus saw a nearly 7.5% sequential increase in net income in Q2, so this was a soft guide down, which could be one of the reasons for the stock’s under-performance relative to the group.
Short dated options prices appear relatively cheap, with 30 day at the money implied volatility about 26%, well below the 52% in early February, and very near the 2016 lows:
Looking out to September expiration, the term structure is pretty flat, with at the money options prices not that much higher than current levels, setting up decently for long premium directional strategies, or calendars.
So whats the trade?
I think you keep it simple, and buy puts, looking to capture the company’s Q2 earnings results on July 15th and the FOMC’s July 27th meeting.
*C ($45.50) Buy Sept 45 Put for $2.30
Break-even on Sept Expiration:
Profits: below 42.70
Losses: up to 2.30 between 42.70 and 45, with max loss of 2.30 above 45.
Trade Rationale: I am not choosing to spread with vol low and downside premium looking dollar cheap, with a move through the long put strike I will look to turn into a vertical spread by selling a lower strike put in Sept.