While expectations for higher interest rates are hanging over the U.S. market, bank stocks reflect little of the anxiety and options traders see no end to the gains.
They’re snapping up bullish contracts on the biggest financial exchange-traded fund as investors pile into bank shares at the fastest rate since 2008. The ratio of calls to puts on the ETF is near the highest level since 2012 and the cost of hedging against losses has fallen to an 11-month low, according to data compiled by Bloomberg.
Wall Street firms, at the center of the financial crisis seven years ago, are regaining investor confidence amid optimism that the Federal Reserve’s plan to raise interest rates will bolster profits. While bears cite heightened regulations and the risk of credit turmoil, money is flowing to the industry after banks reduced leverage and shored up balance sheets.
“People are looking at financials as a low-risk investment under the assumption that they will be relatively resilient in a rising rate environment,” Channing Smith, a managing director at Capital Advisors Inc. in Tulsa, Oklahoma, said by phone. The firm oversees about $1.5 billion and recently added holdings in regional banks. “Even a modest rate increase will have a material impact on the profitability of these companies.”
Financial shares are the second-best performing industry in the Standard & Poor’s 500 Index this quarter, rising 4.6 percent. JPMorgan Chase & Co., American International Group Inc. and Bank of America Corp. have rallied more than 14 percent. The group rose 0.3 percent at 4 p.m. in New York.
Analysts forecast earnings for the industry will rise 5.6 percent this year, compared with 1.2 percent for the broad market, data compiled by Bloomberg show.
The benefit of higher rates will filter through to net interest margin, or the difference between what a bank pays in deposits and charges for loans, which hit a record low in the first quarter as the Fed has held its benchmark rate in the range of zero to 0.25 percent since 2008.
While the central bank said on June 17 that any increase will come gradually, the prospect of higher rates has spurred options traders toward maximizing gains.
For every 100 bullish contracts on the Financial Select Sector SPDR Fund, 112 puts were outstanding. That’s near the highest ratio since 2012, data compiled by Bloomberg show. Options protecting against a 10 percent drop in the ETF cost 6.16 points more than calls betting on a 10 percent rise, three-month data show. The spread, known as skew, reached 5.07 on June 16, the lowest since July.
“It tells a relatively bullish tale,” said Jim Strugger, a derivatives strategist at MKM Partners in Stamford, Connecticut. “When the Fed begins to tighten, it’s generally perceived as healthy for financial shares.”
After pulling $5.2 billion out of financial ETFs in the first quarter, investors are piling back in, depositing $3.4 billion since March, data compiled by Bloomberg show.
Buying banks based on higher interest rates is too simplistic and fails to recognize the increased burden that regulators have imposed on the industry, according to James Abate, the chief investment officer of Centre Funds.
“Banks as a whole represent a lower, or no-growth investment with the potential for some type of shock to credit some time down the road, particularly if we think the economy might decelerate,” Abate, whose firm manages $1 billion from New York, said by phone. “The return on equity will remain suppressed for the foreseeable future.”
The advance in banks and insurers has coinciding with a surge in U.S. Treasury yields, which serve as a benchmark for borrowing costs in everything from mortgages to auto loans.
The Fed will raise rates for the first time since 2006 in September and lift them to at least 1.5 percent next year, according to the median forecast of more than 50 economists in a Bloomberg survey.
“Financials have been largely left out the past two years and only in the last few months started to kick off,” Sam Turner, a fund manager who helps oversee $5.2 billion at Richmond, Virginia-based Riverfront Investment Group LLC, said in a phone interview. Among market laggards such as energy and industry stocks, “financials may have been painted as one sector with the most amount of catalysts in the form of higher rates and a better economy,” he said.