My readers have known for months that stock market breadth was narrowing dangerously. While the Dow Jones Industrial Average hung near the 18,000 level, fewer and fewer individual issues were holding the index aloft.
One of the few areas of strength were financials, with the big banks demonstrating relative strength as long-term Treasury yields rose on expectations of an interest rate hike from the Federal Reserve later in the year as well as hopes of an economic reacceleration after a soft start in the first quarter. Between May and the mid-July highs, the Dow basically went nowhere while the Financials SPDR (XLF) gained nearly 6%.
The catalyst cited by many a bullish trader was the expansion in what’s known as the net interest margin — the difference between short-term and long-term interest rates. This directly impacts financial sector profit margins. And it was expanding nicely.
Until it stopped: Treasury yields have been collapsing since mid-July on a combination of factors. For one, doubts are growing over a September rate liftoff from the Fed amid soft inflation and a lack of wage growth. Moreover, the Chinese currency devaluation this week has unleashed global market turmoil, from a drop in Italian bonds to the slamming of crude oil prices, as currency volatility increases. That’ll hit investment banking revenues, from trading to IPO underwriting.
As a result, the Wall Street banks are getting hit extremely hard — creating short-side or put-option opportunities in these four names.
Morgan Stanley (MS)
Morgan Stanley (MS) shares are testing their 200-day moving average for the first time since October, wiping away all the gains seen since April. This comes despite better-than-expected quarterly results in late July, featuring a 13.2% rise in revenues. Investors are obviously pricing in a downturn for the second half of the year.
That movement has pushed up the August $38 MS puts I recommended to Edge Pro subscribers on Monday to a gain of more than 115% already.
Bank of America (BAC)
Bank of America (BAC) shares have dropped out of their two-month consolidation range. The company reported strong quarterly results on July 15, and enjoyed an upgrade from analysts at Argus shortly thereafter. But a rapid contraction in net interest margins has soured sentiment.
Shares have dropped below their 50-day moving average and are at risk of breaking the uptrend started in March. As a result, the BAC August $18 puts recommended to Edge Pro subscribers on Monday are already up more than 122% with room for more.
JPMorgan (JPM)
JPMorgan (JPM) shares have been flatlining since reporting mixed quarterly results on July 14, with a miss on revenues, which fell 6% on a drop in fixed income markets revenue.
Shares have now broken the eight-month uptrend that started in January, setting up a test of the 200-day moving average — which would be worth a 6% decline from here.
Goldman Sachs (GS)
Despite reporting strong results on July 16, Goldman Sachs (GS) shares have been on the slide ever since as investors viewed the results as messy due to the impact of litigation expenses.
With shares plummeting towards their 200-day moving average for the first time since January, the August $200 puts recommended to Edge Pro subscribers on Aug. 7 are up more than 78%.
Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters. Free two- and four-week trial offers have been extended to InvestorPlace readers.
