Finding Trades In A Cautious Financial Sector

With hopes of a recovery in 2023 rapidly waning, the stock market slumped in February and is struggling to reverse the trend in March. With the Federal Reserve expected to continue its wave of interest rate hikes and regulatory crackdowns making companies across the financial sector hesitant about investing in new acquisitions or assets, traders aren’t finding many bullish signals on the horizon. Here’s what you may want to keep in mind as you trade the pessimistic yet resilient financial sector over the next few months. 

Fintech Was Victim to the Large Tech Selloff in 2022, but the Agile Sector Has Some Bright Spots

Like the overall tech sector, fintech ended 2022 in a sharp decline and started 2023 with widespread layoffs. This was partly in response to the same macroeconomic pressures that the rest of the market is facing, like inflation and recessionary fears, but also the settling of pandemic-era trends fintech companies expected to become permanent. 

While there’s little optimism this year, the slowed economic recovery and possible recession represent a potential opportunity for fintechs that focus on flexible, affordable consumer financial services and products. For example, as rising prices strain consumers, buy now pay later (BNPL) services are expected to grow. 

Regtech (regulatory technology) is also poised to grow as the financial regulatory environment grows more stringent and more complex in the wake of crypto market collapses and controversies around account aggregator data security and privacy. As financial institutions try to keep up with changing compliance demands, adaptable and flexible regtech solutions are becoming a necessity. That and other banking industry-targeted tech solutions could present hedging opportunities as the sub-sector stands to gain on any news of regulatory crackdowns and other industry challenges. 

Rising Interest Rates Could Ultimately Boost Banking Sector Profitability, but Not in the Short Term

In March, Fed Chair Jerome Powell spoke of higher and faster rate hikes this year than previously anticipated as inflation spiked unexpectedly in January. If this month’s consumer price index *and February jobs report show more inflation and stronger employment growth, that could crush any hopes that rate hikes will pull back anytime soon. 

Traders may also want to watch for the Fed’s quarterly rate projections and policy decisions in May. But expect a lot of that pessimism to be already baked into the price as the uncertainty about a recovery in 2023 has already slowed down momentum. Goldman Sachs and Bank of America both forecast the Fed rate to climb as high as 5.5% so only a surprise increase higher than that is likely to trigger a significant fall in the stock market. 

While rate hikes tend to improve profitability for banks in the long term by widening the spread between interest paid on deposits and interest earned on loans, the short-term hit to their balance sheets makes them vulnerable to the current economic headwinds. 

M&A Activity Will Likely Be Slow and Infrequent in 2023

Toronto-Dominion (TD) Bank first announced a $13.4 billion acquisition of Memphis-based First Horizon Corp in February 2022 but, like many other M&A deals in the banking industry, the acquisition faced intense regulatory scrutiny. The slow process has pushed back the closing date on this deal repeatedly. The most recent pushback extends the closing date to May 27, but weeks after that announcement, TD and First Horizon were doubtful even that date would hold up. 

While analysts still believe the deal will eventually close, the now more than one-year delay could force the banks to renegotiate the price, and the risk that it could end up just falling apart grows with each extension. 

The TD-First Horizon deal is not the only one in regulatory limbo. Provident’s merger with Lakeland Bank has been pending since September and isn’t expected to close until the second quarter of this year. Both of Prosperity Bank’s acquisitions announced in October – FirstCapital Bank of Texas and Lone Star State Bank of West Texas – were initially expected to close in the first quarter of this year but still remain pending. 

With regulatory scrutiny on M&A activity expected to remain high, traders should brace for softer lifts following announcements as the market becomes more skeptical about whether deals will actually be approved. That also means it will take longer for acquisitions to impact earnings releases. 

Learn About Direxion’s Daily Financial Bull (FAS) and Bear (FAZ) 3X Leveraged ETFs

In the midst of ongoing uncertainty, one way that traders may maximize the resulting short-term volatility is by using leveraged ETFs like Direxion’s Daily Financial Bull (FAS) and Bear (FAZ) 3X Shares. The ETFs seek daily investment results, before fees and expenses, of 300%, or 300% of the inverse (or opposite), respectively, of the performance of the Financial Select Sector Index (IXMTR)*. There is no guarantee the funds will meet their stated investment objective. Weighted primarily in the banking and capital markets sectors, IXMTR includes banks and other financial service providers, including the following top 10 holdings:

INDEX TOP TEN HOLDINGS % as of 3/31/23. Holdings Subject to change and risks.
Berkshire Hathaway - Class B	14.85
JP Morgan Chase	10.50
Bank of America	6.17
Wells Fargo	4.20
Charles Schwab	3.39
Goldman Sachs Group	3.10
Morgan Stanley	2.99
S&P Global	2.98
Blackrock	2.84
Chubb	2.44

 

For traders, leverage is a way to potentially magnify the performance of each trade, for losses as well as gains, but when used carefully, there may be an opportunity to turn the market’s rocky attempt at recovery into profitable trades. Featured photo by Sean Pollock on Unsplash

This post contains sponsored advertising content. This content is for informational purposes only and not intended to be investing advice.

 

*Consumer Price Index (CPI): CPI measures the monthly change in prices paid by U.S. consumers.

The Financial Select Sector Index (IXMTR) is provided by S&P Dow Jones Indices and includes securities of companies from the following industries: Banks; Thrifts & Mortgage Finance; Diversified Financial Services; Consumer Finance; Capital Markets; Insurance; and Mortgage Real Estate Investment Trusts (REITs). One cannot directly invest in an index.

An investor should carefully consider a Fund’s investment objective, risks, charges, and expenses before investing. A Fund’s prospectus and summary prospectus contain this and other information about the Direxion Shares. To obtain a Fund’s prospectus and summary prospectus call 866-476-7523 or visit our website at www.direxion.com. A Fund’s prospectus and summary prospectus should be read carefully before investing.

Leveraged and Inverse ETFs pursue daily leveraged investment objectives which means they are riskier than alternatives which do not use leverage. They seek daily goals and should not be expected to track the underlying index over periods longer than one day. They are not suitable for all investors and should be utilized only by sophisticated investors who understand leverage risk and who actively manage their investments. 

The “Financials Select Sector Index” is a product of S&P Dow Jones Indices LLC (“SPDJI”), and has been licensed for use by Rafferty. Standard & Poor’s® and S&P® are registered trademarks of Standard & Poor’s Financial Services LLC (“S&P”); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”); and these trademarks have been licensed for use by SPDJI and sublicensed for certain purposes by Rafferty. Rafferty’s ETFs are not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, or their respective affiliates and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability for any errors, omissions, or interruptions of the Financials Select Sector Index.

Direxion Shares Risks – An investment in each Fund involves risk, including the possible loss of principal. Each Fund is non-diversified and includes risks associated with the Funds’ concentrating their investments in a particular industry, sector, or geographic region which can result in increased volatility. The use of derivatives such as futures contracts and swaps are subject to market risks that may cause their price to fluctuate over time. Risks of each Fund include Effects of Compounding and Market Volatility Risk, Leverage Risk, Market Risk, Counterparty Risk, Rebalancing Risk, Intra-Day Investment Risk, Other Investment Companies (including ETFs) Risk, Cash Transaction Risk, Tax Risk, and risks specific to the securities of the Financial Sector. Performance of companies in the financials sector may be materially impacted by many factors, including but not limited to, government regulations, economic conditions, credit rating downgrades, changes in interest rates and decreased liquidity in credit markets. Additional risks include, for the Direxion Daily Financial Bull 3X Shares, Daily Index Correlation Risk, and for the Direxion Daily Financial Bear 3X Shares, Daily Inverse Index Correlation Risk, and risks related to Shorting. Please see the summary and full prospectuses for a more complete description of these and other risks of each Fund.

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