Is it Time to Get Back Into Bank Stocks?

Bank Stocks

While many investors have marveled at how stock indexes have held up so well during this big recession, when it comes to bank stocks, investors do not look the other way.

2020 has been mostly a story of the rise and fall of stocks, or rather, the fall and rise of them. From a fundamental perspective, while we could argue for some sectors to be immune to the particular recession that we are now in, the fact that we have lost so much economic ground due to what has been a super-sized recession has not had the effect upon the overall market that people would have thought.

Not all stocks have been passed over or even mostly passed over by the recession, and some, like bank stocks, have remained sick in bed over this time. 2020 has been an epic year for a lot of stocks, not just a mildly nice one in the face of what has simply been an economic disaster, but one that some stocks took off in a way we never even see.

While stock indexes have long moved on from the crash, and have since gone higher than ever, the benchmark Invesco KBW Bank ETF is still down for the year by 32%. While they have come back from further down than this, their recovery has flatlined over the last 3 months while the broader market left them behind for higher heights.

Meanwhile, their sister sector ETF, the Invesco Technology Momentum ETF, even after getting slashed on Thursday, is still up 39% on the year. Sectors generally move in the same direction, with the exception of the energy sector which has been terrible in all years lately, but the bank sector has joined them in the dungeon this year.

2020 has seen the biggest gap in history between the haves and the have nots, with the best stocks performing well beyond what anyone could have even hoped, with the worst, like bank stocks, losing an extra amount.

2020 also separated those who know what they are doing and those who do not, where those bold enough to ride the fast horses that have raced around the track being very well rewarded for their stock selection, while those who are not fussy about what they hold missing out on most of the move.

Those who actively pursue the slow ones have been particularly punished, and this does include anyone who did not just run for their lives when the lockdown started and everyone knew that banks would be getting particularly punished by this, as they do in recessions.

Those who are seeing bank stocks looking a little bullish from here, stuck in a sideways pattern after getting thumped earlier in the year, might have their hopes buoyed if they knew that the only reason why they have struggled so much since COVID-19 hit is due to investor preference, but this still leaves us with the prospect that investors may continue to prefer to avoid them. This is especially a concern since we saw the VIX start to rise again and this portends some big selling if the market is in the mood for such a thing.

We’ve been waiting for the market to wake up to the alarming risk of the Democrats consolidating their power in Washington, and while they have been able to look the other way for the most part from the path of economic destruction that we have chosen, we even have trouble seeing them ignoring what is a much bigger threat, not due to its magnitude as much as its duration.

When you lock down the economy like we did, you can’t do that for long, much like you can’t hold your head underwater for too long, or you will simply die. The lockdown proceeded exactly according to plan, regardless of what the “experts” wanted, even though many were not aware enough of the necessity to re-open things and lived in a fantasy world, but this was not a fantasy that could ever come to pass. It didn’t take much expertise in economics to know this, even though so-called health experts wore their ignorance of economics like a badge of honor.

We already saw the worst recession in over 80 years as it was, one that was even competitive with the Great Depression for a time, with the difference being that this one was a brief depression, and it really had to be as far as how long we could keep the country’s economy underwater. If we were prepared to appoint Tony Fauci King over our economy, as Biden wants to do, not that he could anyway, and lock things down for a lot longer, the pain that we felt from this and still feel could have been so much worse.

We didn’t though, and the end of the tunnel was always in sight with this issue, but if the tunnel is extended not for a couple months but for 4 years at least, that will not only lock us down, it will throw the economy in prison for that long. The economy does not do so well in prison, especially in its injured state.

As far as what we should be doing with our stock positions, this requires the greatest of care going forward, as the election appears closer and closer on the horizon, and with the market not yet wanting to price in the risk of this, there has to be a time where they start. That time may already be here, with the VIX rising over 25% over the last few days, from under 20 to over 26, and this carrying over to stocks on Thursday, the worst day for stocks in months.

What is really notable about this selloff is that not only have the good stocks not been spared, they have taken more than their share of it. There are two ways that stocks go down, losing comparative value where money in the market gets distributed to other stocks more in favor, which is the one we’ve seen since the March bottom, and the one where money gets pulled out of stocks period, like what we saw during the crash and what we also saw on Thursday.

Thursday’s Selloff Was the Most Ominous One We’ve Seen Since March

We can’t even pin the worst day since June for the S&P 500 and the Dow, and the worst day since March for the Nasdaq, on anything else but this fear rising, but you don’t need anything but fear to reign to see markets take some big tumbles. Fear itself is the enemy, and the recession only scared markets for a while and then brushed this off, but there may be another storm brewing.

Perhaps people were looking for Donald Trump to make a bigger move than this, where he did get a little bump but not much yet from the aftermath of the battling nomination conventions, but there is some big money being taken out here, money that has gotten a little scared, a good amount of it already.

When you see stock indexes drop this much in a day, this is due to an overwhelming bias to the downside with sell programs. Program trading is the big kid on the block anyway, and normally feeds the market big orders more gradually, and when you see COVID style selling again, unloading that much in a single day, this tells us that this may be serious.

The VIX, otherwise known as the Volatility Index, went from 11 to over 56 during the period between February 18 and March 18, and it was no coincidence that the peak of the VIX and the market low with stocks both occurred together. This is how we were able to call the bottom the very next day, and it wasn’t that the VIX just dropped, it started to drop as fast as it rose. In just 4 trading days, it had fallen from 56 to 38. It made it all the way down to 20 in August, but is now heading the other way again.

The VIX is also referred to as the fear index, and there’s no better way to measure fear in the market than looking at this indicator. You can trade the VIX as well, by way of the ProShares VIX ETF, who allow you to trade the VIX in both directions with both standard and inverse ETFs which are also available with leverage.

Even at 2X, the VIX is too tame normally to be traded with an ETF full time, where you can do this but need to pick times where things are particularly volatile. People trade this directly in the futures market with a lot more leverage, enough to make the usual small moves this makes meaningful and profitable. We can also use options on VIX futures to help protect our stock positions, given that this goes up a lot during times of panic, the sort that investors need to protect themselves from somehow, whether by hedging or just running away.

The reason why this index is so predictive is that it measures the amount of hedging that the market engages in, and if the level of concern goes up enough to have the VIX moving significantly to the upside, fear of a decline has them not only hedging more but being ready to sell more.

In times of high fear though, like we saw during this one month of frenzy, or when it comes down these steep mountains, you can make good money trading this at 2X. It is on the way back up now, and while very few investors would ever trade this index, everyone needs to watch it. It is starting to look more scared now, and when this happens, investors need to allow themselves to be a more scared as well.

We need to provide a little backdrop before we start looking at these bullish recommendations that several analysts have just put forth with bank stocks, especially since these analysts do not know their way around these things and don’t even pay attention to them. You’ll never even hear them say much about market sentiment because they don’t realize this matters, and it’s actually the only thing that matters. They are looking to the horizon as they drive down the stock highway, not even paying attention to what is in front of them on the road, and there’s plenty on the road right now.

Not only do these analysts not see what is in front of them, they expect us to do the same. They spend their days poring over their view of how stocks play out in the future, at a time where there is a very significant potential for stocks in general to go off the road, and even more noteworthy, for banks to take their usual bigger share of declining economic fundamentals.

In a country run by the most radical people since the American Revolution, and a radicalism that is the complete opposite of the country’s founding fathers who saw a new and better way to run a country, the prospects of having radical socialism come to town, in a vicious incarnation, with the President, the House, and the Senate dancing menacingly around the fire and offering the economy up as their sacrifice is nothing to ever take lightly.

We’ve told you that this is a market that we do not want to just walk away from while the party is going on, but at the same time, we need to keep our eyes open for a turn in fortune. This may just be the outer bands of this hurricane, but the wind has really picked up right now, and we really need to have our hands on our guns now as the mob may be coming for us soon.

The upward trend in the VIX since August 25 already had us concerned, especially when we saw the flames rise so high in the overnight trading prior to the open Thursday. Investors need a higher threshold to scare them, but ours is much lower, and we love big selloffs as traders, and Thursday was a great day to trade the major indexes if you were on the right side of the ball.

Bank Stocks Are the Last Place to Be During a Storm

Waking up to a riot in progress in the market on Thursday morning left little in doubt as to the direction that the day was going to take, but this looks more like it may be much more than a one-day opportunity, and one that investors need to heed as well. Those who were planning on riding this train through the end of 2020 and beyond need to look at all that snow on the tracks, where even though we have been able to plow through plenty of snow, there are some big snowbanks that may be coming up that can knock us off the tracks and have us wishing we were paying more attention. The time for wish for that is before the wreck.

The people that analysts speak to are not traders, they are the sort that will hang on to their recommendations for a year or longer, usually considerably longer, as just shooting to hold something for a year makes you a position trader. While it is a good idea for investors to learn how to become position traders, a lot have no interest in this, and want others to do all the thinking for them. You then need to be careful who you listen to.

Gerard Cassidy, managing director of RBC Capital Markets, just told us that “based upon the valuations and the outlook for the economy in 2021, we believe bank stocks can be purchased with the expectation the group outperforms the general market over the next 12-18 months.”

Cassidy is not alone, as analysts have just warmed up to bank stocks in general over the last few days, but we need to make sure that we’re looking down the track ourselves, as they don’t bother as this view does not make its way up the stairs to their ivory towers.

This is a very good snippet of how these people think, and while there are times where advice like this can at least be fairly reasonable, in spite of his using the ugly word “valuation” which is the hobgoblin of many investing minds. When bank stocks finally recover, it won’t be from valuation, as theirs look very tempting but aren’t tempting much in the real world. The most we can say from a low valuation is that the stock is disliked by the market, and the market disliking a stock is a purely bad thing, never a good thing.

We also keep a close eye on economic forecasts, and if you just go by this, bank stocks shouldn’t really be looking all that bad, maybe not beating the market but at least holding their own from here, but this assumes all things remain equal, and they may very well not be.

We like the idea of bank stocks getting a little bounce from people finally understanding that this pandemic really is going away, and as the numbers continue to decline, this will become harder and harder to deny. Even the case count, which is a foolish thing to look at anyway, has been going down for 6 weeks, in spite of ramping up testing as much as we have, which in itself raises case counts proportionately. Even the ramping can’t keep this from falling anymore.

This factor has had us liking stocks right from the late March bounce, but this isn’t the only potential change to the way that the market has viewed things between here and this 12-18 months, there’s also Joe Biden and his angry troupe.

This risk doesn’t show up in the economic forecasts, as these things are not done contingently, but contingent events coming to pass can tip their canoe and see them heading down the rapids head first. COVID-19 was one of these events, but no one saw that coming until at least the pandemic started, but the prospect of apes taking over Washington completely for 4 years is an even scarier one, and one that can easily be envisioned now.

This risk is substantial enough that we cannot think of a single stock we’d want to plan on keeping for 12-18 months without deciding as we go, not the best of them, and certainly not the weakest of them. This is not a time to be thinking long-term, even with those who long to and are uncomfortable about taking measures to protect them. Some people regretfully ignore evacuation orders, and a great many stuck around for the last hurricane, but this is not something we should be encouraging.

You’d never see someone like this advising people to invest in shorter-term timeframes than this, or to even be on their guard, as badly as this may be needed. They instead ignore the weather, even when the skies completely darken. We should not be so willing to follow them in their ignorance. We need to at least be open to avoid the worst storms, and there at least could be a big one coming.

We recommend stocks as well from time to time, but never without an eye toward managing risk with the trade, whether this be over a few hours, a few days, or a few years. You might prefer to only trade cars every 10 years, but when the car starts to break down, sticking with it can leave you stranded and very unhappy, where deciding to keep it this long ended up being presumptuous.

People who own stocks have different thresholds of pain, from the minor move that would get a trader out to the big stuff that everyone feels pain from, but we should never wish to accept whatever pain may come.

When we buy a stock, we assumingly see a positive potential for it over the next while, and this requires that we look at it from all sides, not just from one or two views. We agree with Cassidy that there may be a time where bank stocks may take off faster than the market, but that can only happen when the smoke from COVID-19 clears enough that people’s confidence in bank stocks can recover enough.

With a potential wildfire coming our way which could fill the air with smoke once again, where financial stocks will be punished even more if our economy gets punished with the higher taxes and regulation that Biden and company are planning, bank stocks are particularly risky right now. This is not a journey that we should wish to take without an evacuation plan.

Until their upside increases and especially until their risk declines enough, the risk/return ratio of bank stocks remains inferior, and we’d be better advised to wait at least until a time that the storms have passed and the sky clears, and when the market says it’s time to party again.

Monica

Editor, MarketReview.com

Monica uses a balanced approach to investment analysis, ensuring that we looking at the right things and not confined to a single and limiting theory which can lead us astray.

Contact Monica: [email protected]

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