Financial Stocks Could be Positioned to Kick Off the Q4 Earnings Season

The U.S. dollar was rising against the Japanese yen Tuesday morning as foreign investors take notice of the jump in United States Treasury yields. The Japanese yen is now trading at a three-year low against the dollar. The U.S. dollar Index ($DXY) is working on a two-day rally against a basket of other currencies.

The falling yen prompted a rally in Japanese markets. The Nikkei 225 (N225:JP) rose 1.77% overnight. Japan hasn’t had the same inflationary problems as other countries, so the Bank of Japan is still pushing economic stimulus. If the yen continues to weaken, it could help the Nikkei 225 continue to gain ground.  

Equity index futures were trading higher before the bell as stocks hit the final official day of the Santa Claus rally. The S&P 500 futures (/ES) rose a quarter of a percent in premarket action. If investors follow through after the opening bell, the S&P 500 could be set to create another all-time high. The Dow Jones Industrial Average futures (/YM) were also up 0.27% in premarket trading and looking to create a new all-time high too.

Energy stocks could lead other sectors again on Tuesday because crude oil futures (/CL) were also trading higher on Tuesday morning rising 1.13% in premarket trading. The commodity looks to be bouncing off an important support level. Consumer staples could also be set up for a good day because some of its companies are seeing analyst upgrades. Coca-Cola KO was upgraded by Guggenheim from neutral to a buy. Yesterday, McDonald’s MCD was upgraded too.

Investors appear to be unconcerned about rising COVID-19 cases. According to data from John Hopkins University, more than 1 million more cases were reported on Monday. One reason the numbers were higher was because of a delay in reporting from some U.S. states. The Omicron variant continues to spread but the case doesn’t seem to be as severe as the Delta variant.

In fact, cruise line Carnival CCL was among several travel and leisure stocks climbing in premarket trading. Travel and leisure have been among the hardest companies hit by COVID-19 because it has hit all workers including pilots, flight attendants, baggage handlers, and more.  

The airline was able to influence a dispute between the United States government and AT&T T and Verizon VZ over the companies’ 5G plans and how they might affect airline safety. The telecom companies were providing an alternative plan. But after airline unions started speaking up over the safety issues, AT&T and Verizon decided to push their plans back two weeks to reconsider the safety concerns.

After the opening, the ISM Manufacturing PMI report will provide investors with a measure of manufacturing strength by analyzing new orders, order backlogs, imports and exports, production, and inventories. The JOLTS Job Openings report will also be released. Both reports carry the potential to move markets, so traders will want to be aware of them.

Monday’s Action

The 10-year Treasury yield (TNX) rallied 7.67% on Monday as investors dumped bonds to open the new year. While the S&P 500 (SPX) appeared to benefit from investors leaving bonds by rallying 0.64%, the buying wasn’t particularly broad because the NYSE advancers outpaced decliners by about 1.26 to 1. The rally in the 10-year yield helped bank stocks as the PHLX KBW Bank Index (BKX) rallied more than 2.62%. Wells Fargo WFC led S&P 500 financial stocks by rallying 5.73%, followed by Citibank C and Bank of America BAC, which rose 4.49% and 3.80% respectively.

Despite the big rally in the 10-year yield, a 1.12% rally in oil prices (/CL) helped boost energy stocks to the lead for the day. The Energy Select Sector Index ($IXE) rallied 3.15%, followed by the Consumer Discretionary Select Sector ($IXY) at 2.88% and the Financial Select Sector Index ($IXM) at 1.24%. Investors also favored value stocks to growth stocks with the S&P 500 Pure Value Index ($SP500PV) rising 1.40% and the S&P 500 Pure Growth Index ($SP500PG) falling 0.65%.

However, one growth stock that bucked the trend was Apple AAPL, which rallied 2.50% and became the first company to reach a market cap of $3 trillion, although it was only for a moment. Apple reached $2 trillion in August of 2020 and $1 trillion in August of 2018.  

Tesla TSLA is another popular growth stock that zigged when other growth stocks zagged on Monday. Tesla helped to lead a rally in electric vehicle makers by closing 13.53% higher and is a little more than 2% away from its all-time high.

Handling the Curves

The yield curve steepened dramatically on Monday with the rally in the 10-year yield, which could reverse the trend through December. Over the previous month, the 2-year Treasury yield grew from 0.56% to 0.73% for a 30% increase, while the 10-year grew from 1.43% to 1.52% for a 6% increase. The steeper yield curve is often seen as a good sign for the economy. However, it could also reflect that the Fed is buying fewer bonds and focusing on shorter maturities in hopes it can steepen the curve. When the bond-buying program ends in a couple of months, the market will be freer to determine the price of money. 

CHART OF THE DAY: FINANCIAL FITNESS. The Financial Select Sector Index ($IXM—candlesticks) outperformed the S&P 500 (SPX—pink) in 2021. However, the sector has weakened against the SPX in relative strength (green) since June. Data Sources: ICE, S&P Dow Jones Indices. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.  

Fiscally Fit?: Last week we discussed how the energy and financials sectors had the lowest valuation with an average forward P/E ratio of 10.5 in energy and 14.1 in financials. An interesting note about these valuations is that energy and financials have lower valuations despite outperforming the S&P 500 throughout 2021.

Some of the largest banks and financial firms will kick off earnings season this month, and many of these companies have low valuations. On January 14, JP Morgan JPM, Wells Fargo WFC, and Citigroup C report earnings. Currently, these companies have to trail 12-month P/E ratios of 10, 11, and 6 respectively. The following Tuesday lists many financials including Bank of America BAC, which has a P/E of 13, and Goldman Sachs GS, which has a P/E of 6.  

We’ve observed many times last year that investors have been favoring value stocks, which could bode well for many financial stocks. Additionally, continued rallies in the 10-year yield would likely keep these stocks moving. Finally, if these companies are able to top analyst expectations, they could receive additional attention.

Dogs of the Dow: The Dogs of the Dow used to be a popular strategy where investors would purchase the 10 highest-yield stocks in the Dow Jones Industrial Average ($DJI) from the previous year at the beginning of the new year. These stocks were often the worst-performing stocks in the index the previous year, thus the moniker “Dogs”.

The strategy was popular because the Dogs would often outperform the Dow 30 the next year. However, the strategy fell out of favor over the last decade because investors focused more on growth and less on income or value. Additionally, a focus on stock buyback programs over dividends has likely contributed to less interest in dividends. However, with rising interest rates and a resurgence in value investing, this strategy may find some viability once again, but only time will tell.   

Check for Fleas: At the end of 2021, the top 10 yielding stocks of the Dow Jones Industrial Average included Dow Inc. (DOW) as in Dow Chemical, which was yielding 4.94%, followed by Verizon VZ at 4.93%, IBM IBM at 4.91%, Chevron CVX at 4.57%, Walgreens WBA at 3.66%, Merck MRK at 3.60%, Amgen AMGN at 3.45%, 3M MMM at 3.33%, Coca-Cola KO at 2.84%, and Intel INTC at 2.70%.

Of course, there’s danger in purchasing a stock just because of its high dividend yield because there’s no guarantee that a stock can continue paying dividends in the future. Investors should evaluate the company’s ability to generate earnings to pay dividends to feel more confident when investing in an income stock.

TD Ameritrade® commentary for educational purposes only. Member SIPC.

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