Dividend Stocks

Bank Stocks Are Heating Up as Tech Stocks Falter. How to Play the Trend.

Bank stocks are starting to show some signs of life relative to the broader S&P 500.  I’ve had a few guests on my Lead-Lag Live podcast who have noted that it looks like a good setup for financial stocks here. I think this makes some sense. The recent decline in long-duration Treasury yields has been a welcome respite for bank stocks, given the eased collateral pressure on government debt held by these institutions. I had floated that idea before that to save banks, you need to save Treasury bonds. That seems to be part of the reasoning here.

The decline in long-term rates has other implications beyond collateral, however.

As rates fall, it eases lending pressure. Should this continue, at the margin, it allows for more lending by banks against an already indebted economy, resulting in increased profits at the margin. However, it is crucial to note that this short-term momentum is just that – short term. As we shift our gaze to the longer-term view, a different picture emerges. The commercial loan market looks to be downright scary.

As default risk rises among borrowers, banks are left grappling with the potential for significant losses on their commercial loan portfolios. These challenges are further compounded by higher interest rates.

Despite the recent drop in Treasury yields, the Federal Reserve’s rate hike cycle has negatively impacted the net interest income (NII) of banks, forcing them to pay more to retain depositors.

So, we have some interesting dynamics here. In the short term, Treasury strength appears to be benefiting bank stocks, but that’s all happening against a backdrop that still favors a recession and a broader credit event. As I always say, you can be bullish and bearish at the same time depending on time frame.

Short-term relative strength is there, yes. But how long will it last against bigger headwinds?

The Bottom Line on Bank Stocks Here

Bottom line? Consider time frames here. The commercial loan market looks set for a rough ride. Small-cap stocks, should they reverse and weaken, suggest there remains lingering concerns over zombie companies. In turn, this would negatively impact banks.

I’d be more comfortable making a relative spread trade that is long financial stocks and short technology stocks to play relative strength. Regardless, it’s worth tracking financial stocks to see the mood of the market into the new year.

On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

The Lead-Lag Report is provided by Lead-Lag Publishing, LLC. All opinions and views mentioned in this report constitute our judgments as of the date of writing and are subject to change at any time. Information within this material is not intended to be used as a primary basis for investment decisions and should also not be construed as advice meeting the particular investment needs of any individual investor. Trading signals produced by the Lead-Lag Report are independent of other services provided by Lead-Lag Publishing, LLC or its affiliates, and positioning of accounts under their management may differ. Please remember that investing involves risk, including loss of principal, and past performance may not be indicative of future results. Lead-Lag Publishing, LLC, its members, officers, directors and employees expressly disclaim all liability in respect to actions taken based on any or all of the information on this writing.

Michael A. Gayed is the Publisher of The Lead-Lag Report, and Portfolio Manager at Tidal Financial Group, an investment management company specializing in ETF-focused research, investment strategies and services designed for financial advisors, RIAs, family offices and investment managers.

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