The financial rotation

It has been barren land for the financial for the past five years. With all that has gone on in the markets regarding leverage followed by easy money, the financials have never been the same. The financials have clearly underperformed the wild markets in the past year, while the tech space has been on a merry ride with the large caps spitting out enormous amounts of free cash flow (the likes of Apple and Microsoft) and the small guys (Netflix, Splunk, 3d systems) providing the enormous potential growth. But that might be about to change.

The thing to keep in mind here is that the markets are run by financials. The first rule in the market is that the market makers always make money. The unprecedented involvement of the fed in the markets have curtailed the ability of the financials to make money in the past few years as easy money is making it hard for the financials to widen their spreads. Risk taking is back and with all the money sloshing around, everyone is trigger happy on the likes of 3D systems.

In the past six months, the interest rates have shown a propensity to go higher given the risk of the feds pulling back a bit from the markets. Though the trend has not been well established, the bottom seems to have been made for the easy money regime. In the last couple of months, most financials have broken out of their trading range and headed higher. This in all probability is a trend for the next year as people start seeing the spreads widen and the financials back in the driver seat.

The problem however is my inability to value financials. They hold very high leverage ratios and their balance sheet is loaded with liabilities. This however is not to be necessarily to be feared with the leverage being a key part of their business model. But what is scary is that I cannot tell from their balance sheet if it is good or bad leverage and the true extent of leverage. I learnt this lesson with my Citibank holdings during the 2006 timeframe and paid dearly for it. However, having learnt that lesson I am not going to swear away from financials. After all, they are the most integral part of the markets.

So while I was bleeding money in Citibank in 2008 I decided that the best way to play in the space in spite of my inability to value them, is the XLF. So I open position in XLF during that time and have held it since. I accumulated some as it worked its way through the teens and held it steady for the past couple of years. Now again I see a breakout in XLF in the last two months. And I think it is time to accumulate further.

At most financials trading at 9 times earnings, I think there is some ways for the financials to run further as people rotate from tech into financials. Barring a calamity in the markets this rotation is inevitable and I think it is time to expand my holdings. This time around, however, I am only expanding in XLF and looking for an opportunity to dump C when the opportunity is right. I like the diversification in XLF and gives me a sense of security (albeit a false one) about my financial holdings.


  1. This is yet to play out. Small upside thus far, but the financial have started showing consistent profitability. Hopefully the tide will turn when the spreads widen for the 10/20 bonds.


Post a Comment

Popular Posts