For the past several months, we’ve been talking about the worries hanging over the markets. Rising interest rates, trade wars, inflation, and an extremely tight labor market caused the markets to drop and volatility to increase.
But it’s not all bad news out there. The U.S. economy has improved over the past two years and the U.S. dollar is moving higher. There’s even talk of 4% economic growth in the near future. All of these are perfect conditions for small-cap stocks.
And at the end of April, we told you about one specific industry that would be the beneficiary of the good and bad news …
Regional banks. Have you been following them?
In April, we gave you a couple of reasons why we like the regional banks.
Regional investment banks are mostly small- and mid-cap companies that do most of their lending locally rather than internationally, so they don’t have as much exposure to vulnerable emerging markets.
And regional investment banks are also seeing a positive bottom line benefit from rising rates, through the ability to earn a higher profit on their lending spreads. As a bonus, because of their domestic focus, regional investment banks aren’t as exposed to other international worry factors (like trade war).
Since the beginning of the year, the large-cap multi-national banks like JP Morgan and Goldman Sachs have been struggling. XLF, the SPDR Select Sector ETF for the financial sector, is down almost 1% year-to-date. In comparison, the S&P 500 is up a little more than 4% this year.
The regional banks, however, have been shooting higher. KRE, the regional banking ETF we told you about, is almost 9% higher for the year.
KRE triggered a Stock State Indicator (SSI) Entry signal in November 2016. It traded in a narrow range for almost a year and was less than a dollar away from stopping out in early September 2017.
It recovered and moved out of the SSI Yellow Zone shortly thereafter. Even with the market volatility of 2018, KRE hasn’t entered the SSI Yellow Zone this year.
KRE is a modified equal-weight ETF, so no one position overpowers the others in this ETF. The top 10 stocks that make up KRE account for only 20% of the overall index and all of these top 10 stocks are currently in the SSI Green Zone.
In the past two years, this is the first ETF we’ve examined with all 10 stocks in the Green Zone.
We wouldn’t be surprised to see more capital flow into the regional banks. Many industries have negative exposure to the rising rate trend, but for regional banks it’s a positive.
Also, these banks have almost no exposure to the international issues that are beginning to worry the overseas markets.
I expect that we will continue to see small-cap stocks and the domestic regional banks lead the markets higher in the weeks and months to come.
Richard Smith, PhD
CEO & Founder, TradeSmith