Relative Strength and Value in Financials Has Ended

The Financial Sector ETF (XLF) has been one of the biggest beneficiaries of a Trump election victory but it appears that the easy gains in the banks are gone. The SPDR S&P Bank ETF (KBE) has risen 47% over the past year and more than 22% since the election. The combination of higher interest rates and a Trump preference for deregulation in the industry has been a strong tailwind for the sector. Now, however, it looks like the relative strength of the sector has dissipated and traders should be looking to lock in the last few month’s gains.

Bank stocks generally reported strong results in Q4 although JPMorgan Chase’s (JPM) report that indicated profitability missed internal targets dampened the mood. The issue with the “Trump Bump” is two-fold. First, bank stocks have begun trading on what Trump policy might look like, not necessarily what it will look like. Trump wants to ease deregulation and chop up Dodd-Frank but that still needs to go through a lengthy legislative process in order to happen. Second, any improvement in a Trump economic environment is still a ways off from actually showing up in the financial statements and there’s still some balance sheet improvement that needs to occur, particularly in the regional banks, to confirm a longer term bull trend.

Financials have traded at much lower multiples compared to the broader market as investors waited for interest rates to help boost their profits. Since Trump was elected, much of the relative value in the sector has disappeared. Financials traded at around 12 times forward earnings as recently as about a year ago but now have largely been eliminated from the value discussion. The Financials ETF trades at around 15 times forward earnings now, still cheaper than the 18 multiple of the S&P 500 (SPY) but much closer to the sector’s historical norms. The Bank ETF has a forward P/E of 18 which puts it into fully valued territory.

From a technical standpoint, the relative strength of the sector looks to have ended too. The relative strength indicator of the Bank ETF, which was in the 80s in December, is now back to under 50. The Bollinger Bands have contracted in the sideways trading of the last several weeks and now sits right on the lower band. That could indicate short term technical support for the ETF or it could signal trouble if it wants to break through. The 50 DMA is also rapidly approaching. Keep an eye on whether that level can hold.

At this point, it looks wise to lock in gains. Trump is going to need to go from just talking to actual governing at which point we should have a better idea of what the financial industry landscape will look like. I’d take some chips off the table here and look to re-deploy when we get a few more answers.

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