Financials Flying too High?

Hey There Income Hunters,

 

I have always loved the Masters tournament, which concluded its 85th edition on Sunday.

 

Augusta National is the most beautiful course on the planet …

 

I bet on the X-Man, Xander Schauffele, heading into this weekend (+900), and for a while during a back-nine charge I thought he had the Green Jacket in the bag.

 

Xander walked off No. 15 with a fourth-consecutive birdie and headed to the 16th tee with all the momentum …

 

Sixteen is a beautiful par-3 with water on the left that doesn’t come into play (often).

 

Xander teed off first with an opportunity to put the pressure on … but he missed the green entirely and his ball rolled into the pond.

 

Game over.

 

Afterwards as I was preparing for the week, I ran across a potential trade in the Financial Select Sector SPDR Fund (Ticker: XLF) …

 

Yet another X with momentum that could be heading for a drop-off!

 

Having worked inside Wall Street banks for most of my career, I know that when the Fed is injecting a ton of money into the banking system the XLF trends higher … 

 

However, as soon as the trend reverses, #IncomeHunters should short XLF and ride the correction to lower prices …

 

Important Signals


There are two important signposts that indicate whether XLF will continue to trend higher or a change coming — and I have them for you here …

 

1. The 2-Year/10-Year Yield Curve Spread

 

As you will see in the chart below, the XLF very closely tracks the 2-year/10-year spread, a key US Treasury securities yield curve spread. (It measures the slope of the Treasury interest rate curve, which is both a barometer for bank profit margins and a guide for where companies should issue debt to most efficiently manage their borrowing costs.)

 

The reason is, Financials make up the vast majority of their revenues via securities financing transactions. Profit margins for this “funding” business are completely reliant on the slope of the yield curve …

 

Now, because short rates are close to zero today, banks borrow money for free. They then invest those funds by issuing mortgages to homeowners at 4-5%, which is a great profit margin …

 

But notice below how the 2-year/10-year curve is starting to narrow. This could be the beginning of a correction, which would narrow banks profit margins and cause a downturn in XLF prices …

 

 

2. Track Volume and the Relative Strength of the Uptrend

 

There are two things that I group together and look for to see if a market may be rolling over:

 

        • Higher prices on less volume
        • A divergence between prices and the relative strength of those prices…. 

 

Both favor lower prices in the short-term as the chart below illustrates …

 

 

The Trade

 

Yesterday I paid .72 cents for an outright $35 strike in XLF expiring on May 21… I will stop myself out on a close above $35.50.

 

I have to take the emotions out of the trade and give it a go when the signs show a possible down turn… 

 

 

Bring It Home

 

I have many opinions about what I believe our financial system needs in order to get back to a strong and robust economy that can survive on growth and productivity.

 

We need a banking system that understands the small-to-medium enterprises (SMEs) of our nation are the hidden champions that represent two-thirds of employees nationally …

 

Banks should lend to that sector instead of hoarding money for personal profits by gambling in the markets.

 

I honestly believe that we will see real bank reform in the years ahead that will help drive much-needed change so America can look forward to a truly vibrant economy once again.

 

Live and trade With Passion My Friends,

 

Griff

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