The Trend Is Your Friend With Financial Stocks

Includes: BAC, C, JPM, NLY, WFC
by: Regarded Solutions

No matter how hard the Fed tries to push longer term treasury yields down, I believe they have reached the point of diminishing returns. The recent trend of the longer term rates has been up, in spite of the $85 billion spent every month by the Fed on Treasuries and mortgage backed securities. In this case, that old axiom should hold true; the trend is your friend. Especially when it comes to financial stocks.

Specifically big banks as well as mREITs.

As of this writing, the 10 year Treasury is over 2% once again. I believe that trend will continue as money moves out of bonds and into equities. With a zero interest rate policy still in effect, at least until 2015, the spread that banks and mREITs have to make money has widened further.

Two weeks ago, I wrote this article, in which I noted some key reasons as to why I believe that the financial sector could lead the entire market higher:

  • A zero short-term interest rate policy [ZIRP], that allows banks to borrow at near zero interest rates. This in turn allows the banks to lend, even with rates at the longer end of the curve remaining low, and make money.

  • The Fed continues to buy $85 billion in longer-term Treasuries and mortgage backed securities, monthly. This keeps rates lower than they would ordinarily be, which has the effect of offering very attractive loan rates to both individuals and corporations.

  • By keeping the "lid" on interest rates, the housing sector has been able to gain some traction, which of course inevitably leads to more mortgages being written by these banks, no matter what the standards are.

  • The Fed has repeatedly stated that this policy will be in place until the unemployment rate drops below 6.5% and the inflation rate goes above 2.5%

The banking sector, of which I believe the leaders to be Bank of America (NYSE:BAC), Citigroup (NYSE:C), JPMorgan Chase (NYSE:JPM) and Wells Fargo (NYSE:WFC), have continued to rise in share price.

Outside of WFC, the other 3 banks are up nicely since my previous article, and I believe that this trend will continue. If the banks can keep borrowing at near zero rates, and the "spread" to lend has widened, then greater profits should be rather easy for these banks to make.

The trick has been to ramp up the mortgage loan business to keep the housing sector moving ahead. Now that the CFPB has detailed mortgage lending guidelines, I feel that the banks will be willing to approve more mortgage applications. As I noted previously:

The CFPB has defined the standards in the report noted, and not only does it help the consumers realize they can only afford what they can really afford, but this agency has also mitigated much of the litigation risks that each of these banks faced.

The key points of the new standards are quite simple:

  • The debt-to-income ratio cannot exceed 43% to qualify for an FHA mortgage.

  • Qualified mortgages would not have interest-only features, nor balloon payment "trip-ups."

  • There would be a 3.5% cap on loan origination fees.

  • Banks that conform to these standards will be shielded from future litigation.

If the banks open up their wallets a bit more, then revenues and earnings should follow back into the banks. I also believe that the mREIT sector could benefit by having a more stable lending environment, and relatively stable mortgage rates.

The 30 year mortgage stands at 3.53% and the spread that the mREITs can make has widened to a good degree. I have also suggested that Annaly Capital (NYSE:NLY) is worth looking at once again, based on this environment.

Since writing this article, shares of NLY have also rebounded to the current share price of $15.11 from the $14.79 price it was less than one week ago. I believe that the investing world is seeing things quite similar to what I am seeing, and money is flowing back into all of these financials.

The Bottom Line

If we can maintain a stable interest rate environment as well as see a wider spread on the yield curve, I believe it makes sense to own some of these financials right now, at current pricing. In spite of the Federal Reserve's role in this game, it appears that we have some of that stability.

*This article is based on my own opinions, and is not a recommendation to either buy or sell any security. Please do your own due diligence prior to making any investment decisions.

Disclosure: I am long NLY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.