The consensus is that since the 2008 financial disaster, banks are now fortress stocks. But they have failed to live up to the hype so far. Even though they are cheap, Wall Street believes that they can’t rally. So I have put their stocks in the penalty box until the negative narrative dies. After all I don’t want to fight the proverbial tape.
Last week was bad for the stock market but that’s almost expected given the rally we’ve had since the beginning of 2019 and since the last dip on March 8. This time, what scared the markets last week was the flattening yield curve.
That is why the banks got shellacked especially hard last week, much more so than the indices. In fact, the Invesco QQQ Trust (NASDAQ:QQQ) stayed positive for the week. The small caps were hit hard but for the major indices, the price action from last week does not change the general direction of the markets.
The financials were badly hurt because of the dovish tone from the last U.S. Federal Reserve statement. Suddenly we now have confirmation that the Fed will not raise rates this year and only once for 2020. This put tremendous pressure on the 10-year yield.
In theory, a low rate environment is good for stocks. It spurs more, borrowing which brings more growth. But here we have the risk of a flattening yield, which is close to inverting the 10-year against the two-year yields. This is a potential problem for banks.
They borrow short term to lend it long term. So if the yield curve inverts, then banks would lose money if they borrow short and lend long. So this would severely crimp economic expansion because money centers would stop lending.
The experts in the field say that this would likely bring about a recession within 12 to 18 months. I am sure that the statistics are not as black and white as they say, but for now, the perception is truth until investors shake it off.
In other words, this too shall pass but meanwhile, bank stocks remain in the penalty box. Even when they rally, you hear experts say that banks cannot hold their greens so it is futile to fight the tape.
This is not just perception, it is reality. While the S&P 500 is up 11% year-to-date, Morgan Stanley (NYSE:MS) is only up 5% for the same period. And this is the one that Wall Street considers the best of the money centers. In general, the Financial Select Sector SPDR ETF (NYSEARCA:XLF) is only up 6% this year so they trade in unison.
Luckily, all experts also agree that the banks are cheap. Most of them trade at book value and some like Goldman Sachs (NYSE:GS) are even priced for less than its liquidation value. Obviously investors are worried about the future profit and loss statements of these healthy companies.
So how can investors handle something like Morgan Stanley stock now? Those who are in it for the long haul should stick it out and not fret the short-term dips. Over time, the environment will change to where MS will rally off its current depressed value state. After all, Morgan Stanley stock has the overall support of its cheap valuation.
Technically, MS stock had failed at $45 per share once in January and then last week, when it showed so much promise. But it’s no coincidence that it happened.
Pivot points on a chart are areas of contention. They are resistance on the way up and support on the way down. The area around $45 has been pivotal for over a decade. So Morgan Stanley stock now has to deal with it as a roof until it’s broken down.
Meanwhile, the upside opportunity here is slim. There is no imminent breakout situation where investors can buy and hold a few weeks to profit. At this point, unless investors plan on holding MS stock for the long term, I don’t see it as an upside swing trading opportunity.
But since there is value below, I could sell puts into the end of 2019. This would put me long MS, but from a much lower price point. If MS holds the December lows, I would generate income while I wait for banks to fall back into favor. Otherwise, and until resistance is taken out, I don’t chase the rallies.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him as @racernic on Twitter and Stocktwits.