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Banking On A Recovery

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The financial sector trades today as if an economic recovery is imminent. More importantly perhaps, the rally in the financials puts to rest the recent credit concerns. That's not to say they won't resurface. Renewed fear over credit quality is a distinct possibility. But for today, those fears are no where to be found.

The gains across the financial spectrum are far out pacing the market. The Brokers (XBD.X) are better by nearly 5 percent. The Big Banks (BKX.X) are up by more than 3 percent. And the Banks ex-money center (BIX.X) are up by about 2.7 percent. I'm going to focus on the latter two groups for the purposes of this update.

The BKX includes the larger money-center banks, who carry the greatest bad loan risk because of their sheer size. Those financial institutions include the likes of Citigroup (NYSE:C) and J.P. Morgan Chase (NYSE:JPM). Both stocks are components of the Dow and are leading the blue chip index higher today. Shares of Morgan are better by more than 8 percent today, while shares of Citi are higher by more than 3 percent. The out performance of these two stocks is the reason the BKX is out pacing its brother in the BIX.

BKX.X - Daily

The exclusion of Citi and Morgan, however, is the reason the BIX is above its January highs. The BIX contains smaller, regional banks, who typically have less exposure to problem loans. The lack of disconcert over the credit quality among the smaller banks is the reason that the BIX trades better than the BKX, although that dynamic is reversed today.

The BIX is heavier in banks such as Wells Fargo (NYSE:WFC) and Bank of America (NYSE:BAC). Both stocks are breaking out in a big way in today's session on renewed economic optimism and the aforementioned ease of credit fears.

BIX.X - Daily

Two Key Points

First, prior to the last two days, the financials have traded poorly relatively to the broader market measures. Naturally, the group is due to catch-up to the upside if, indeed, the economy is in the clear. We're seeing some of that catch up today with the out performance of the bank measures. Moreover, the sell-off in bonds in conjunction with the rally in the banks reveals that the "scared" capital is growing more confident. That means credit concerns are easing, which is a positive for the economy and stocks in general.

Second, if you're going to play the banks to the upside based upon the gain in relative strength in the last two days as well as the rotation out of Treasuries, then it's better to use the names in the BIX than the BKX. Specifically, the names in the BIX are less exposed to credit concerns, which makes them the higher odds bet in this case. Yes, the likes of Citi and Morgan are oversold, which offers more potential upside, but with that additional potential reward comes additional risk. Names likes Wells Fargo and Bank of America are the higher odds bets that carry less risk.

Eric Utley
Option Investor

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