We’re hearing all kinds of talk about the larger-cap financials like Bank of America (BAC), JPMorgan (JPM) and Goldman Sachs (GS) lately as potential changes to legislation, the potential housing slowdown and rising interest rates offer reasons to reconsider your holdings.
But rather than throwing the banking baby out with the bathwater, we’d instead suggest a look at regionals as a profitable alternative to the large financials.
The SPDR S&P Regional Banking ETF (KRE) — which holds banks such as California’s CapitalSource (CSE), southern operator Synovus Financial (SNV) and the Midwest’s FirstMerit (FMER) — has been on fire lately, posting 31% year-to-date returns vs. 21% for large financials (XLF) and 16% for the S&P 500.
So, why the regionals? A number of reasons.
- Core Business: One reason for the strength in regional banks is their focus on core banking lines of business. These banks tend to operate more traditional businesses that are heavier on deposit-based operations vs. larger institutions’ focus on mortgage lending and investment operations. With interest rates set to move higher over the next few years, it is possible that the regional banks will once again get busy with their deposits and loan business. Higher rates are more likely to inject more money back into these banks’ balances sheets as investors return to the certificate of deposit (CD) as a core of their portfolio given the potential for higher yields.
- Strong Breadth: KRE also looks good to our filters and models, which scan each listed ETF to find those with the highest percentage of stocks hitting new 12-month highs vs. 12-month lows — an indicator that tracks breadth. As of last week, the regional banking fund was the strongest ETF out there with 16% of its constituents posting new highs, and zip — zero! zilch! — hitting new lows. For comparison’s sake, the S&P 500 has just 3% of its stocks hitting new 12-month highs and the same amount bottoming out.
- Short Squeeze Potential: In addition to that positive breadth, KRE also benefits from a unique sentiment signature that suggests it’s likely to continue outperforming. We’ve looked at aggregate short interest for the companies making up the KRE, and they’re the most heavily shorted group — meaning any continuation in the performance of the shares will cause a short squeeze to engage, pushing prices even higher.
- Analyst Catch-Up: Similarly, we’ve noticed that analyst rankings on KRE companies are well below the average for the market. This suggests that the analyst community has some catching up to do in terms of upgrades — upgrades that will help drive these prices higher.
So, how do we play this strong ETF sector?
Click to Enlarge Keep it simple and just play the KRE! The recent pullback in the market created a small opportunity for investors looking to add exposure to the regional banks. KRE is priced at $36.55 — just below its 20-day moving average. The fund still has potential support from its 50-day, which is trending higher, at the $35.70 level.
We would consider current prices as an attractive buying point for KRE, with a target of $39 over the short-term outlook.
As of this writing, Johnson Research Group did not hold a position in any of the aforementioned securities.