Friday, March 21, 2014
The mainstream media is finally catching on to my favorite trade for 2014.
In December, I told you to buy big banks.
I said several catalysts would help the sector easily outperform the market this year.
Last week, Barron's agreed with me. The well-respected publication told its subscribers to "buy the financial sector. If you already own it, buy more."
Now, the trends I mentioned are finally taking form. And banking stocks are about to break out.
Let me explain...
In December, I told you one of the catalysts that should result in big profits and higher share prices for banks is rising interest rates.
Since my essay, interest rates have gone nowhere.
But on Wednesday, the Federal Reserve announced a further reduction in its bond-buying program (a form of quantitative easing meant to keep interest rates low). The 10-year Treasury bond jumped over 3% on the news in anticipation of higher interest rates.
Rising interest rates are widely viewed as a negative for stocks. Borrowing costs for consumers and businesses move higher. Plus, interest rates could persuade investors to move their money out of stocks and into interest-paying alternatives.
But higher interest rates are great for banking stocks. That's because the spread between the cost to borrow money and the actual rates banks can charge their customers widens – creating bigger profits.
Banks have plenty of cheap money at their disposal. (The average interest rate on a savings account, for example, is about 0.46% right now.) But with interest rates on long-term debt rising, banks can lend that money back out at much higher rates – say, in a 30-year mortgage at 4.3%. So the more interest rates increase, the more money banks make.
Even if rates don't push higher, Barron's says there's another short-term catalyst that could push shares higher. Big banks may be looking to spin off some of their assets.
Large-cap banks have huge trading divisions, credit-card portfolios, and asset-management businesses that are worth billions of dollars.
With new government regulations coming, banks may look to sell off these non-core assets.
These assets are in high demand. There are plenty of hedge funds, private-equity shops, and regional banks that would line up to buy these cash-cow businesses. So large banks can sell these assets for a great price, increase their cash flow, and avoid dealing with the new government regulations. The news of a sale would push big-bank shares higher.
But the most important trend I told you about was that large banks were looking to return capital back to investors in the form of dividends.
After the credit crisis, the government placed restrictions on banks paying dividends to investors. But with bank balance sheets stronger than ever, Barron's says the Federal Reserve is expected to give big banks permission to raise their dividends at the end of the month.
This is a big deal.
Banks are still one of the most-hated sectors in the market.
The government continues to bring lawsuits against the industry. And the fact most of these names had to be bailed out for taking on excess risk during the credit crisis still leaves a bad taste in the mouths of investors.
This has made the sector dirt-cheap. The big banking fund XLF trades at just 12 times earnings. XLF's holdings include Bank of America, Citigroup, JPMorgan, and Wells Fargo. The S&P 500 trades at 15 times earnings.
However, dividend-paying stocks trade at a premium to the market. That's because it's difficult to generate income in a record-low-interest-rate environment.
For example, the Utility Select SPDR fund, which yields 3.6%, trades at 17 times earnings. The Consumer Staples Select SPDR fund, which yields 2.4%, trades at 18 times earnings.
When banks are allowed to increase their dividends, shares should trade at least in line with the S&P 500. That's a gain of 25% from current levels.
Bank stocks should easily outperform the market going forward. If you have no exposure to this sector, I suggest buying a few names today.
Find more of Frank's favorite trades this year right here:
Six Stocks for the Oil and Gas "Megaprojects" Spending Spree
"If you haven't invested in the oil-services sector yet, this word will help you see what's happening… and how big the opportunities are."
My Favorite Way to Invest in the Offshore Oil Boom Right Now
"One of my favorite infrastructure companies is selling off right now. And it's presenting a great buying opportunity..."
How to Strike It Rich in the New Internet "Gold Rush"
"More than 99% of things in the physical world remain 'unconnected.' But that's about to change..."
The Canadian dollar falls to a four-year low versus the U.S. dollar.
Health care stocks are soaring... UnitedHealth and Aetna hit new all-time highs.
Coal producers continue their brutal downtrend... Walter Energy and Alpha Natural Resources plunge to new multiyear lows.
Crops are breaking out... corn and wheat prices jump 10%-plus over the past three months.