Making the Case for Trading Financial Stocks
On Wednesday, March 21, 2018 the Fed FOMC moved to hike the Federal Funds Rate. The FFR is now 1.50% – 1.75%. Fed Chair Jerome Powell pulled the trigger by raising the interest rate 25-basis points. This trend is projected to continue through 2018 and 2019. The short-term impact of a rate hike is negative for equities. An interest rate hike triggers concern among equities investors on several levels. For starters, higher interest rates lead to reduced profitability since listed companies are required to contribute more to the repayment of their lines of credit. Fortunately, Wall Street bourses price interest rate hikes into the equation well ahead of time and the net effect is somewhat muted on the day.
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The interest rate announcement did not shift the needle too much on the day. The Dow Jones Industrial Average slipped 0.18%, the S&P 500 Index dropped 0.18%, and the Nasdaq dropped 0.26%. Overall, US indices remain long-term bullish with double digit gains over the past 1 year. It is interesting to point out how the US Dollar Index is performing. The DXY is a broad measure of the greenback against a basket of 6 currencies including the GBP, EUR, JPY, SEK, CHF, and the CAD.
This index serves as the bedrock for determining overall dollar strength. Typically, the DXY is supposed to appreciate when the Fed raises interest rates, but that hasn’t happened. Various other factors feed into dollar strength of weakness, foremost among the Fed interest rates. Currently, the US Dollar Index is hovering around the 52-week low at 89.56. For the year to date, the DXY has depreciated by some 2.79%, a strong improvement over the 1 year performance which reveals a 10.24% decline.
Are Rate Hikes Good for Bank Stocks?
A strong USD does not bode well for commodities like gold, Crude Oil and other dollar denominated financial instruments. The reason for this is clear: It costs foreign buyers of these commodities much more in their native currency. This is the reason a strong dollar is not the panacea for many economic challenges. From an import/export perspective, when the USD is strong relative to other currencies the costs of exports is more to foreign buyers so demand decreases. Imports become relatively cheaper with a strong USD.
The Fed Chair did not indicate anything vis-à-vis future rate hikes. For the remainder of 2018, an additional 2 rate hikes are expected. This will certainly help to boost the profitability of financial stocks like JPM, BAC, C, and WFC accordingly. Every time the Fed hikes rates, banks increase their spread (difference between interest rates charged vs interest paid on deposits). The impact of a Fed rate hike on stocks needs to be evaluated against specific asset sectors. Certain stocks are highly sensitive to interest rate movements, and it’s important to watch what is happening with the monetary authorities vis-à-vis these stocks.
Consider the current price trajectory of the bank stocks:
- JPMorgan – is trading above the 50-day MA and the 200-day MA at $114.74 (March 21, 2018)
- Citigroup – is trading mid-way between its 50-day MA and the 200-day MA at $73.32 (March 21, 2018)
- Bank of America – is trading above its 50-day MA and the 200-day MA at $31.87 (March 21)
- Wells Fargo & Co – is trading below its 50-day MA and the 200-day MA at $54.79
Barring the performance of several financial companies, the general trajectory is positive. There are many reasons why banking and financial stocks are looking positive right now, including:
- Interest rate hikes boost bank profitability
- Deregulation makes it easier for banks to do business
- Tax breaks benefit banks in a big way with 21% corporate tax, down from 35%+