Friday Morning Market Comments, Calendars

Morning Market Commentary:

  • Federal Reserve members have said they're in favor of "tapering" bond purchases by year's end.
  • The last tapering cycle ran from December 2013 until the first rate hike in December 2015.
  • The Financial Select Sector SPDR Fund rallied 74% from the start through the end of 2017

Yesterday, we laid out the metrics on why we think upward momentum should continue in the financial sector...

Today, we're looking at history to help us see how that scenario could play out.

Rising rates are music to bankers' ears. When rates go up, bankers are well-positioned to make more money on loans.

You see banks make higher margins when the spread between the two- and 10- year U.S. Treasurys widen. Thought of another way, that's the difference between what banks pay you to borrow that money in your savings account (two-year Treasury) and what they charge individuals who want to borrow from them (10-year Treasury).

Right now, the two-year Treasury yield is 0.21% versus the 10-year yield at 1.31%. That means banks are earning 1.1% on the loans they're making. A year ago, that same spread was 0.6%. So, those same banks are earning almost two times the return on loans now than they were a year ago. And if the Fed tightens monetary policy, those returns should increase even more...

Consider the Financial Select Sector SPDR Fund (NYSE: XLF), as a way you can profit from that trend. The fund is made up of 66 large-cap financial companies from the banking, insurance, and credit-card sectors. Its top holdings include Berkshire Hathaway (BRK-B), JPMorgan Chase (JPM), Bank of America (BAC), and Wells Fargo (WFC).

Let's look at what happened when the central bank began tightening policy after the 2008 to 2009 financial crisis.

First, take a look at the XLF chart below...

Back then, like now, the Fed was purchasing large amounts of Treasurys and mortgage-backed securities. Its balance sheet rose fivefold. In the past 14 months, that same balance sheet has doubled.

But eventually those bond purchases came to an end as the economy stabilized and recovered from the crisis. The same scenario is going to play out soon... By the end of this year, the central bank is likely going to recognize it needs to pull back on all its spending because the economy has returned to pre-pandemic levels.

In December 2013, the Fed said it would begin scaling down bond purchases. Two years later, in December 2015, it hiked up interest rates for the first time. By the end of 2017, the federal-funds rate had increased a total of five times to 1.3%.

Yet, if your $10,000 had been sitting in a one-year certificate of deposit account during that period, you would have averaged a 0.2% return, or around $80. If you owned the SPDR S&P 500 ETF (SPY) over the same time period, you would have a 61.2% return on your money, including dividends, or $6,120. But if you owned the XLF, your return would have been 74.1%, or $7,410. You would have almost doubled your initial investment.

Currently, XLF pays a 1.5% dividend. So not only are you participating in improving margins, but you're also getting paid to own the stock.

However, there's an added catalyst. That rate is going up. During the onset of the coronavirus pandemic last year, the Fed halted banks' stock buybacks and limited dividends. It wanted to make sure they were adequately capitalized. But recently, it has allowed banks to resume both.

So, don't let the consequences of policy decisions taking place in Washington, D.C., hurt you financially. Instead, prepare now by using our knowledge of the past to take advantage of what's to come and profit from it.


MANU before the open.


U.K. Consumer Inflation Expectations for Q3 (4:30 a.m.)
Eurozone Final CPI for August (5 a.m.)
Preliminary University of Michigan Sentiment for September (10 a.m.)
Baker Hughes Rig Count Data (1 p.m.)
Fed to Offer $500 Billion in Overnight Repo (1:15 p.m.)
CFTC Commitment of Traders Report (3:30 p.m.)