Introducing A New Way To Trade Financials: Big Banks Are Targets For Traders

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Includes: BAC, BBT, C, GS, IYF, JPM, KBE, MS, PNC, SCHW, USB, WFC, XLF
by: REX Shares, LLC
Summary

Most financial sector indices dilute their bank exposure by including non-bank financials.

REITs and insurers make up a large portion of many “financial sector” indices.

If you trade a view on Banks, be careful what you choose.

If you’re trading the financial sector, you’re probably familiar with gyrating big-bank related headlines. You may even like them. Bank stocks can move, up or down, on all kinds of news. Just this month big banks surged and then retreated in a span of three days with headlines like:

  • “Bank stocks (except Wells) surge amid strong results”
  • “Wall Street dips after lackluster big bank earnings

For traders, this kind of volatility can be a welcome and potentially profitable opportunity, especially if you can find a pure play on the largest, most closely followed names in the banking business. The Solactive MicroSectors U.S. Big Banks Index, may give you exactly that.

This index represents the most concentrated U.S. big bank exposure available, even compared to financial sector indices from the big name index providers. Before we fully explain our U.S. Big Banks Index, it’s important to understand what exactly is in other financial indices.

Financial Sector Index landscape: know before you trade

Most financial sector indices dilute their bank exposure by including non-bank financials. For example, the top three constituents in the S&P Banks Select Industry Index, by weight, aren’t banks: they’re in the insurance and lending businesses.

More importantly, REITs and insurers make up a large portion of many “financial sector” indices. These non-bank stocks can have a very different response to certain market and economic developments compared to bank stocks. And some “financial sector” indices even include foreign banks, which may be subject to a very different interest rate, regulatory and legislative regimes, compared to the biggest U.S. banks.

  • The Russell 1000 Financial Services Index is only 27% banks - the rest is insurance (13%), real estate (18%), diversified financial services (26%), and even software & services (15%)! Software obviously behaves very differently to bank stocks.
  • The Dow Jones U.S. Financials Index is only 29% banks - the rest is a mix of real estate (20%), insurance (14%), software & services (9%), and diversified financials. Real estate often moves in the opposite direction from banks on macro news, like interest rates.
  • The S&P Financial Select Sector Index is 42% banks - the rest is diversified financial services with an 18% weighting to Insurance Companies, which significantly dilutes the sector exposure for traders looking for a pure play on banking moves.
  • The S&P Banks Select Index claims a singular focus on “Banks” but that bank exposure includes small, mid, and large cap names, across sub-industries like asset management & custody banks, diversified banks, regional banks, other diversified financial services, and thrifts & mortgage finance. The top 3 holdings in this “banking” index are LendingTree (TREE), AXA (OTCQX:AXAHY), and Voya (VOYA) (as of 4/15/19).

The Solactive MicroSectors U.S. Big Banks Index fills a gap in the marketplace for sector-specific trading products that deliver precisely targeted exposure, particularly in this highly traded sector where investors had few pure-play options - until now.

Financial Sector Index breakdown: if you trade with a view on banks, be careful what you choose

Source: Bloomberg, as of 3/31/2019

Why did we launch the Big Banks Index?

We created MicroSectors indices to provide investors and traders a new benchmark for the most closely watched & biggest names in a given sector, in this case the banking sector. Traditional financial indices include insurance companies, advisory firms, credit card companies, software firms and even REITs. Maddeningly to us, their REIT exposure rivals their bank exposure, which can act as a counter balance under certain economic conditions: REITs typically sell off when rates rise, and climb when rates fall, which is the exact opposite behavior of a typical bank stock. We believe traders may benefit by breaking the financial sector into miniature sectors, or MicroSectors, specifically and starting with a U.S. Big Banks sector.

What is the Solactive MicroSectors U.S. Big Banks Index?

The Solactive MicroSectors U.S. Big Banks Index includes 10 highly liquid stocks that represent industry leaders across today’s U.S. banking sector. The index’s underlying composition is equally weighted across all stocks, providing a unique performance benchmark that allows for a value-driven approach to investing. While the performance of cap-weighted benchmarks can be dominated by a few of the largest stocks, equal-weighting allows for a more diversified portfolio. Reference our website for important information and guidance on how to invest in this index.

Solactive MicroSectors U.S. Big Banks Index Holdings:

Source: Bloomberg, market cap data as of 3/29/2019

Laser focus on the names that lead the sector

Bank stocks can be driven up or down by all kinds of developments: Fed moves on interest rates, economic growth, inflation data, yield curve moves, political and legislative news, earnings, stress tests, or any number of other factors. But it’s the biggest, most highly traded names in banking that may give you the pure play you’re looking for.

The Solactive MicroSectors U.S. Big Banks Index features just the names you know, in the sector you’re following. We focus on these stocks because they are some of the most traded, and followed names in U.S. equity markets. Many would even consider these the leaders in banking.

On the NYSE, Bank of America (BAC), Wells Fargo (WFC), JP Morgan Chase (JPM) and Citigroup (C) are all among the top-25 most traded names. Daily trading volume for Bank of America alone (avg. 65 million shares) is more than several times that of ExxonMobil (XOM) (avg. 10 million shares). And financial sector index linked ETFs (beta/delta-1 & Leverage/Inverse products) are among the most traded products, according to ETF.com.

The 10-stock basket in the Solactive MicroSectors U.S. Big Banks Index also features some of the most-followed names in the sector. These 10 stocks constitute only about 10% of the S&P Banks Select Industry Index, by weight. But they take up the majority of social media velocity for that entire index: 61% of all “follows” are for these 10 stocks.

Social Media Velocity Comparison: S&P Banks Select Index vs. MicroSectors U.S. Big Banks Index

Index constituents per Bloomberg 4/11/19. REX Social Velocity score based on number of followers for each constituent across news and social media channels such as Stocktwits.

Bottom line: Big Banks are here to stay

Love ‘em or hate ‘em, big banks aren’t likely going anywhere. The recently announced BB&T (BBT)/SunTrust (STI) merger is just more evidence that consolidation continues to occur in the banking sector. Will Congress bust up the big banks? (We believe that’s unlikely - but if you disagree, you could trade on that, too!) Will the recovery falter and pull down interest rates, or will it rev up and push the Fed back into hiking mode? What about the easing of stress test regulations, or changing inflation data, or flagging consumer sentiment, and record corporate borrowing?

There’s no shortage of issues buffeting the banking sector. So if you have strong views, and you want to trade banks (not REITS, insurance co’s, credit card providers, software co’s, etc.), we believe this index is the way to do it.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This information is not intended to be investment advice. Past performance does not guarantee future results.