The Fed Is Done… So Bet On This Sector ASAP
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Pundits are out there squabbling whether the latest stock rally has legs. Respectfully,they’re missing the bigger picture.
The Fed is done raising rates.
Those six powerful words mean relief for stocks is near. And the shift has already begun.
There’s one sector of the market that stands to benefit most from the conditions we’re seeing today. I think you should bet on it today, and I’ll tell you exactly what it is.
But let’s first review last week’s unforgettable rotation, which led to what I’m seeing right now.
Yields Crash and Stocks SoarThe stock market’s Achilles’ heel has been soaring interest rates. Since the Fed began its hiking spree in 2022, most stocks have sputtered.
However, when rates retreat like they are now, stocks explode higher.
Last week in particular was monumental. Not only did the 10-year fall 7% peak-to-trough, but it broke below one of the most followed technical indicators, the 50-day moving avearge.
The 10-year yield peaked at 4.99% on Oct. 19 and fell to 4.52% on Nov. 3. That’s nearly a 50-basis-point repricing.
Given that rising interest rates act like gravity on stocks, it only makes sense that equities rebound when yields crash.
And boy have they. The S&P 500 climbed a mind-numbing 5.85% last week. That’s the best weekly return all year.
But that performance pales in comparison to other areas of the market:
- The Financials Select Sector Fund ETF (XLF) bounced 7.41%. This ETF holds a basket of banks, insurers, capital markets firms, and financial services players.
- The small-cap barometer Russell 2000 Index (IWM) surged 7.59%
- Shunned regional banks (KRE) catapulted 12.22%, more than doubling the S&P
You may be wondering why finanicals and regional banks in particular bounced so heavily.
If you recall, a couple of months ago, I laid out a data-driven case that financials pop the most when the final Fed hike is in.
Folks, professional investors are wagering on a string of rate cuts next year. This is a major pivot from just weeks ealier.
As shown in the chart below, data from the CME FedWatch tool shows investors expect the first rate cut to come in May. That’s followed by the forecasts of another cut in July, one in September, and one more in December:
Falling interest rates is good news for the Financial sector. As I wrote back in September, this can mean:
- More deal flow — Banks can benefit from more deal flow as rates are expected to fall. According to Axios, 2022 was the worst year for the IPO market since 1990.
- Yield curve steepening — As longer-duration rates climb relative to the shorter end, borrowing short to lend long begins to make more economic sense.
- Private equity (PE) resurgence — Lower rates on the horizon should increase the lending appetite of PE firms.
- Mortgage underwriting — As rates go higher, new mortgages become less attractive. Lower mortgage rates will spur home-buying demand.
History proves that the Financial sector is the best performer once the final rate hike is in.
Since 1994, once the Fed is done, this group soars an average of 30% 12 months later:
When you put the evidence together, making a bet on financial stocks right now is smart.
Yields are falling and the pros are betting the Fed is done.
The major shift has already started, with banks leading the cavalry charge.
But how can you make the most of this move?
The obvious way to play this trend is to buy financial stocks. And the easiest way to do that is to buy a basket of them with the Financial Select Sector ETF (XLF).
But you shouldn’t expect incredible gains owning an ETF. For that, you’ll want to own the best financial stocks in the market.
And for an excellent tool to help you find them, you should check out Ratings by TradeSmith.
Our Ratings software considers nine different metrics to give you the picture of a stock’s health in a fraction of a second.
All you have to do is scan through the XLF holdings (easy to find within TradeSmith Finance), check the rating of any individual tickers, and you’ll quickly uncover the best stocks to own within.
And for those looking to trade the small-cap end of the financial universe, especially the wickedly oversold regional banks, Ratings is essential to making sure you only buy the highest-quality names.
As a TradeSmith Platinum member, you already have access to everything Ratings has to offer. Go to your TradeSmith Finance dashboard to get started.
Contributing Editor, TradeSmith Daily