Why I'm Not Piling 'All In' to the Banks: Market Recon

 | Apr 18, 2018 | 7:59 AM EDT
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"A weed is but an unloved flower."

- Ella Wheeler Wilcox


Equity markets did kind of, sort of sell off over the last hour, but from levels that markets had taken higher over the previous 90 minutes. In other words, equities did not truly experience a powerful "risk off" move to cap what had been a "risk on" day. One day does not make a trend, but what I do find possibly telling was the comfort that traders seem to have adding both Discretionary names, and Information Technology names. This includes the FANGs (Facebook (FB) , Amazon (AMZN) , Netflix (NFLX) , Alphabet (GOOGL) ), software (the cloud), and the semi-conductors. Earnings, broadly are solid. Corporate repurchases, and dividends are the buzzwords. Was not all of this already well known? Would not all of this already be priced in?

(For more on the FANGs, see Jim Cramer's Reports of FANG's Death Greatly Exaggerated.)

Quarterly numbers that beats expectations for earnings per share, and for revenues do seem to have been priced in, at least for the banks. For the nation's largest institutions, market reactions have ranged anywhere from lackluster to outright negative. What gives? There are a number of reasons that have held me back from piling "all in" to a space that I readily admit to being naturally attracted to.

There are positives and negatives across the space. Investment banking disappointed at Citigroup (C) . Advisory services dropped at Goldman Sachs (GS) , while operating expenses increased dramatically. Apparently trading well over a volatile period was simply not well enough for investors. Bank of America (BAC) did not even trade very well. Still, all were wildly profitable overall. Just how much of this profit might be attributable to tax reform? According to the Wall Street Journal, that number just for the quarter rises to $2.5B in aggregate for Goldman Sachs, and the four major banks that have already reported (C, (JPM) , BAC, (WFC) ). Perhaps investors see this accomplishment as priced in, but also non-repetitive. Investors also smell trouble elsewhere.

(Jim Cramer discusses the banks, here.)

The Collapse of the Yield Curve

Think the collapsing yield curve does not matter? You might be right. Survey says: BZZZZ!!! Banks under-performing despite what looks like solid earnings? This week, data covering Retail Sales, Business Inventory building, Housing Starts, Industrial Production, and Capacity Utilization have all printed at levels that would be supportive of the current trajectory for monetary policy laid out by the Federal Reserve. This is pushing out the short end of the yield curve, while the deep end of the pool is moving at a much slower pace. Why? Maybe folks are really just not all that "on board" with rising consumer level inflation at this time. If they were, ten year Treasuries would be giving up more than 3% by now. This chart should scare the stuffing out of you.

Talk about rapid deterioration. Gee whiz.

Strike One. There's time, but what this tells me in mid-April is that banks stand to experience far lower net interest margins throughout Q2 than they did in Q1.

Strike Two. If the volatile marketplace stabilizes somewhat, that damages trading revenue.

Strike three? Still a ways off, but should this curve invert well, then we may have bigger problems than we ever wanted within a year and a half or so after that event.

Fear? Bah! We never fear. We keep our heads, and we make reasonable decisions. The economy still shows improvement. You can still trade the space, and have time to prepare for your future. Just don't sit on your hands.

How to Trade Around The Banks

Pick your spots. I sold 40% of my GS just after the opening yesterday. I did not know that the stock would collapse after that? The stock opened above my target price, and I obeyed my set of core disciplines. Now the stock trades where I want to add that portion of my long back on. I likely will this morning. Take a look at Charles Scwab (SCHW) , a financial, but really more of a broker-dealer than a bank. They ripped the cover off of the ball, and the stock reacted well.

E-Trade Financial (ETFC) , a Schwab competitor, reports this Thursday afternoon. The industry looks for EPS of $0.78 on roughly 20% y/y revenue growth. The last sale stands at 58.49 in early Wednesday trade. The stock has traded in a range of about 2.40 over the last three sessions. I do not usually suggest the purchase of options. Usually I like to score the premiums, but a little outlay here might just be worth it.

Both 58.50 puts and calls went out last night at between 1.03 and 1.06. You can wait til tomorrow afternoon to see if some time value erodes further. Even if the equity moves around, these strike prices line up every 50 cents, so there will be a landing spot nearby. Even purchasing one straddle will only cost the investor something in the area of $200. A directional play...half that. Seems to be a risk/reward scenario tilted in the investor's favor. Going out an extra week only increases the cost of the whole straddle by about 60 bucks, and gives one more time to be right.

The Beast

Question? What stock closed at 57.08 last night, up nearly 30% month to date? Must be a chip stock, or a cloud type, right? Hint: The firm reports their Q1 numbers tonight. Hmm... how about Alcoa (AA) ? The former Dow component is expected by the industry to report EPS of $0.60, but whispers around town are for several pennies more than that. Revenue? Wall Street is looking for a rough $3.11B. That would amount to mere year over year growth of 17%, and be the sixth consecutive quarter sequentially that the firm reported positive revenue growth.

There's a lot to like about the modern iteration of Alcoa. From Q4 2016 to Q4 2017, net sales popped from 2.537B to 3.174B. EBITDA more than doubled. Cash and equivalents on hand grew to 1.358B from $853M while total debt actually declined small to $1.404B. Gross profit margins improved, while operating margin nearly tripled from 6.3% to 18.2%. The Current Ratio appears quite healthy, while the Quick Ratio resides in a much less desirable neighborhood. Perhaps that might be less avoidable in an inventory heavy industry such as this.

There are three items for the retail investor to keep in mind here.

One. Markets are obviously pricing in President Trump's 10% tariff on aluminum in general (despite the many exemptions), and more specifically on Rusal (Russia's top aluminum producer).

Two. The stock has run wild. I like the name, but I am flat the name, and I do not chase stocks that behave like this going into their quarterly numbers. The stock is also testing it's all-time high (or at least it's high, since the split with what is now known as Arconic (ARNC) ).

Three. I have been watching AA related options, and they are expensive, indicating at least a two dollar move on the news.

I will wait on this one to see how the market digests the news. If one is compelled to get involved, I would be far more comfortable writing a 54.50 April 20 put at the last sale of $0.68 than I would straight buying the equity. Raises some revenue, and if one is forced to eat the shares, at least the net basis drops to 53.82.

Economics (All Times Eastern)

10:30 - Oil Inventories (Weekly): Expecting -965K, Last +3.3M.

10:30 - Gasoline Stocks (Weekly): Expecting -300K, Last +458K.

14:00 - Beige Book

13:00 - Fed Speaker: New York Fed Pres. William Dudley.

13:00 - Fed Speaker: Fed Gov. Randal Quarles.

Today's Earnings Highlights (Consensus EPS Expectations)

Before the Open: (ABT) (.58), (ASML) (1.17), (MS) (1.25), (SBNY) (2.68), (TXT) (.48), (USB) (.95)

After the Close: AA (.63), (AXP) (1.71), (CCK) (.80), (STLD) (.89), (TMK) (1.45), (URI) (2.55)

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