The financial sector's meltdown played a huge role in the
recession, but in the years since the financial crisis, most of
the big banks have gotten back on the right track, with some now
trading near record highs.
Two of the largest banks in the world are Wells Fargo (
) and JP Morgan Chase (
). Both stocks have bounced back strongly from the recession, and
have recently hit all-time highs.
Both have already reported their quarterly results, soXLF
let's look at the numbers and see what we can learn from their
Wells Fargo kicked off the earnings season for the financial
sector with its quarterly report, and the take-away from its
report was that the financial sector continues to move in the
right direction. What really impressed Wall Street was the
company's mortgage originations, which were up 31% from the first
quarter, a clear sign that rising interest rates were not having
as big an impact as some feared.
During the same period last year, just 44% of mortgage
originations were from new home purchases, but that percentage
jumped to 74% in the most recent quarter.
Wells Fargo stock charged higher following its earnings
Following in Wells Fargo's footsteps, JP Morgan reported its
second quarter results a few days later, topping analyst
estimates on both the top and bottom lines. Mortgage lending and
trading activity were expected to weigh heavily on the bank
during the quarter, but the impact was less than expected, which
translated into a better-than-expected quarter.
Like Wells Fargo, JP Morgan stock edged higher on the
) and Goldman Sachs (
) have also already posted quarterly results, and they too have
been able to outpace analyst estimates.
Based on the earnings reports from four of the biggest banks
in the world, things appear to be moving in the right direction
for the sector.
While things look good for the moment, there are always risks
on the horizon for the financial industry. With the Federal
Reserve cutting back on its bond-buying program, interest rates
are likely to continue inching higher, which will undoubtedly
have some impact on mortgage applications moving forward. The
housing market continues to show signs of strength, but it would
be foolish to assume that the market is immune to a slowdown
resulting from higher rates.
The industry is also vulnerable to falling trading volumes,
and any slowdowns in this area can derail the sector as well.
During JP Morgan's quarter, fixed-income trading revenue was down
15%. While the results were not as bad as some had feared, they
are still a warning sign that things could quickly turn and send
the stock lower.
The take-away from the reports we have seen this quarter is
that the sector remains in good health, but there are still
plenty of reasons to be cautious moving forward. Consequently, I
would like to take a bullish position on the sector, but will
look to diversify any investment, and hedge my trade with a
decent amount of downside protection in case weakness does begin
to enter the sector.
Both of these goals can be accomplished with a trade on the
exchange-traded-fund Financial Select Sector SPDR ETF (
), which holds some of the biggest names in the financial
The ETF is set up to track the performance of the Financial
Select Sector Index. Among its top ten holdings are industry
heavyweights Wells Fargo, Berkshire Hathaway (
), JP Morgan (
), Bank of America (
), and Citigroup.
Strength in the financial sector has resulted in strong
performance of the XLF over the last year, and the ETF is
currently trading just 1.8% below its 52-week high.
A nice hedged trade on XLF would be the December 16/21
bull-put credit spread. To set up this trade, you would sell the
December 21 put while buying the same number of December 16 puts
for a credit of 30 cents. The trade has a target return of 6.4%,
which is 15.0% on an annualized basis (for comparison purposes
only). XLF is currently trading at $22.65, giving our trade 6.0%