Here's A Crazy Idea; Buy The Banks!
The government's response to the 2018 mini-bear market and the 2020 COVID recession could provide a blueprint for its response here.
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If you got past the title of this piece, that hopefully means you’re at least somewhat willing to hear me out on this. It’s likely to be counterintuitive to what you’re feeling at the moment if you’re following the turmoil in the banking sector, but it’s important to separate the macro landscape from the investability landscape. With respect to the latter, there’s a case to be made for buying bank stocks here.
Since the beginning of 2022, the markets have almost exclusively been trading on inflation and the Fed. Mostly, that has meant pricing in higher and higher interest rates, which has dragged both stock and bond prices lower at the same time. The past week has marked a sharp reversal back to traditional risk-on/risk-off behavior.
Stocks have been on the decline, led lower by bank and financial shares, but traditional safe havens, such as gold and Treasuries have been soaring.
That’s a good thing for investors because, for the first time in nearly a year and a half, it provides the opportunity for portfolio protection that hasn’t existed for a while. Of course, that comes at the expense of a potential banking sector malaise that was nowhere on Wall Street’s radar as recently as a week ago. The million dollar question is are these isolated incidents or a sign of a large systemic problem.
Is this the great financial crisis 2.0? Certainly not today and unlikely to be in the future. So far, we’ve got two bank failures - Silicon Valley Bank and Signature Bank. The former’s collapse was due to poor interest rate risk controls, while the latter was heavily impacted by its exposure to the crypto space (which has had its own issues in recent months). U.S. bank stocks have been falling in sympathy almost across the board with smaller regional banks getting slammed the hardest. This is typical financial market behavior when something like this happens, but we don’t have any evidence (yet) that this will be a problem industry-wide. Financial institutions today are much healthier and better capitalized than they were during the financial crisis and that should help prevent a similar event from occurring again.
That’s the macro backdrop, but here’s the investment case for actually buying bank stocks today despite everything that’s going on. If it sounds familiar, it should because it’s the same thing that happened in 2018 and 2020.
Government intervention!
The best example is what happened in response to the COVID pandemic. The initial market reaction was to sell off all risk assets sharply and violently. Stocks sold off by more than 30% in just one month as investors contemplated the idea of a total global economic shutdown. But then the U.S. government stepped in. Trillions of dollars of stimulus aimed at both households and small businesses. Stimulus checks, extended unemployment benefits, low cost business loans, loan forbearance programs. The government was essentially going to keep the population financially afloat and sentiment suddenly shifted. All of that cash meant the economy would keep churning again and, within months, stocks were back at record highs.
Go back a couple years earlier to 2018 when recession risk was growing in Europe and investors were concerned it would soon spill into the United States. This was during a time when the Fed was trying to normalize interest rates again and was on a trajectory to keep making gradual quarter-point increases. Then, stocks fell by 20% in Q4 of that year and plans changed. Expectations went from three rate hikes in the subsequent few quarters to three rate cuts. Monetary policy was quickly loosened and, again, stocks were back at record highs mere months later.
Flash forward to today and a similar story is already playing out. The government is already stepping in to backstop at-risk deposits at Silicon Valley Bank. JPMorgan Chase and the Fed have provided $70 billion of liquidity to First Republic Bank to help prevent a similar collapse. Last week, the market was pricing in 3+ additional Fed rate hikes before all was said and done. Today, we may already seen the final rate hike and could potentially see a rate cut as early as June.
The market currently expects a net of 50 basis points of rate cuts between today and the end of the year.
The point of all this is to say that the government and big banks are already stepping in to prevent a larger scale failure of the U.S. banking sector. With extra liquidity and lower interest rates usually come higher stock prices. And no sector is more beaten down at the moment than bank stocks.
Full disclosure: I picked up a few shares this morning of the SPDR S&P Regional Banking ETF (KRE). Not a significant amount and only for a short-term trade. It’s currently down about 25% from where it was just a few days ago. My investment case is two-fold. First, added liquidity and lower interest rate expectations tend to usually be a good thing for stock prices after the initial panic has settled. Second, the best time to buy is often when there is blood in the streets. This may or may not be the bottom, but it’s a lot better value today than what it was a week ago.
The natural inclination is to run for the exits in environments, such as these. Remember Warren Buffett’s mantra: be greedy when others are fearful. It could be volatile in the near-term, but the potential payout could be great.
ETFs in Focus
Here’s a look at the weekly net flows/RSI matrix, where I try to get a sense of what the markets are doing relative to what investors are doing to see if there are disconnects.
Note: Most ETFs will fall above the 0% flows/AUM line because, well, ETFs take in hundreds of billions of dollar annually. So I’m looking at 1-month flows to focus on the short-term (1-week flows are too choppy to have high confidence in the results). Upper-left quadrant would identify ETFs that are performing poorly but are seeing investor money moving in. The lower-right quadrant would be ETFs that are performing well, but seeing money leaving. Both could provide contrarian opportunities. I wouldn’t call them buys or sells. Just more of a way of potentially identifying trends.
Almost everything is getting shoved over into the left-hand oversold side of the grid. Bond ETFs, such as AGG, SHV and TLT, have performed well in response to the correction in equities, but investor preference is clearly in favor of T-bills here. The flight to safety trade is back on over the past week and, even though long-term Treasuries have provided the larger overall gains, investors don’t seem at all interested in volatility at the moment. The 4-5% yields combined with almost no share price risk are good enough for the time being.
Instagram Post of the Week
Last week, I put up a post regarding a structural change that’s about to take place within the S&P 500 itself. A total of 14 stocks will be switching into new sectors, the most notable of which are the payment processing companies moving from the tech sector to the financials. The differences will be noticed within the sector ETFs themselves, including XLK, XLI and XLF. About 3% of the index’s overall weight will be shifting from tech to financials, making the latter sector the 2nd largest in the S&P 500.
Overbought & Oversold
Overbought: BDRY
Near Overbought: SGG
Near Oversold: SPLV, MTUM, SYLD, IBUY, SKYY, BLOK, XRT, URA, QQQS, ARKG, VTI, EWA, MCHI
Oversold: XLF, KRE, KBE, XLV, XLRE, CNCR, IBB, DTD, SPYD, IYZ, PBS, IAI, REM, BIZD, IHF, IHE, BITO, EWC, EWS, EWM, FXA, FXC
Note: Oversold/Overbought developed using a combination of RSI and Longbow dashboard.