Apr 11, 2018
The next earnings season gets rolling in just a couple of days, and it’s a big one. For decades, Alcoa (AA) was the unofficial leadoff hitter of each quarterly reporting season, but that company changed its schedule a year ago and now the financials are first up. (Can you tell it’s baseball season?) Healthy financials are a must for a healthy market, so let’s take a look at what to expect and where the biggest profit potential is. (Hint: It’s not where Wall Street is looking.)
If you follow the financial news at all, you know there’s an obsession with interest rates and what the Federal Reserve will do with them. We may not know exactly what will happen from meeting to meeting, but we know the trend: rates are on the rise. Just look at the yield on 10-year Treasury bonds, which has risen from 2.4% to 2.79% this year (a 16% increase). As interest rates increase, banks make more money on what they lend, which in turn boosts the bottom line. In the years ahead, investors should be on the lookout for banks that feature lending as a large portion of their business model.
We’ll get our first look at the bottom line of some of the biggest financial firms this Friday morning, with JPMorgan Chase (JPM), Citigroup (C) and Wells Fargo (WFC) on the schedule to report. I will be especially interested in how higher rates affected their first-quarter numbers as well as their outlooks. We also had the first stock market correction in nearly two years during the quarter, so I want to hear how that impacted business as well.
Expectations are at some of the highest levels I have seen since the bull market began. The financial sector is expected to see earnings grow 19.8% over the first quarter of 2017, which is huge and surpasses the nearly as huge expectations for 17.2% earnings growth for the S&P 500 as a whole. In the big picture, that’s a great sign and indicative of a strong economy. At the same time, higher expectations mean investors will be less forgiving with any misses.
One of the best gauges for the big banks is the Financial Select Sector SPDR ETF (XLF), which tracks the largest financials in the U.S. You can see on the chart above that it recently held its 200-day moving average (the red line) on the most recent pullback and formed a double-bottom pattern with the February low. This is bullish action and positive for the entire financial sector, so investors should be looking for exposure. Wall Street will keep talking about all of the big names we hear about all of the time, and they may do just fine, but I see a lot more upside in playing the financials.
I actually just recommended this stock to my NexGen Investor subscribers, so I’m not yet at liberty to give you all of the details, but let me show you why I think it’s a much better investment to make money on the solid earnings growth in financials and increasing interest rates.
First of all, it’s a smaller bank and one most people have never heard of. Growth is just harder to come by at the giants. Remember “too big to fail” during the financial crisis? It’s more like “too big to grow.” That’s why I look elsewhere. I love these early-stage kinds of investments. The company has actually been around a while, but the stock has really come into its own the last couple of years with more to come.
Second, it’s growing faster than most other banks. Earnings are expected to be up 21% this year and another 26% next year.
Third, it’s an innovative leader in the move to digital and online banking and was the first FDIC-insured bank of its kind. It has low overhead costs and the ability to leverage banking services around the country, all of which help it make even more money from higher interest rates.
And lastly, I like what I see right now from a technical perspective – the chart is indicating a chance to buy. After pulling back from an all-time high in the last month, the stock was able to hold price support and its 50-day moving average. That’s significant because most financials fell through their 50-day averages in the recent volatility, so we can see this stock’s relative strength. The trend remains bullish in the short and long term, and the recent pullback is a buying opportunity.
This is just another example of a situation where you can make money in some of the bigger names that everyone owns, but you can make a lot more in a NexGen leader set to keep growing for years to come.
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