EC Banks Serving Up Big Gains

Volleyball’s a great collegiate sport, despite my alma mater’s abysmal record. One of the things that keeps the game interesting is player rotation. Each time a team wins a side out or gets possession of the serve, the new serving team rotates its players clockwise. Service, thus, isn’t dominated by a single team member.

The same thing happens in the stock market, albeit with less regimentation. Certain industry sectors inevitably attain prominence as the economy cycles between boom and bust. Over the last quarter, for example, we’ve seen capital pour out of defensive issues such as Proctor & Gamble Co. and Coca-Cola Co. and into financial stocks including JPMorgan Chase & Co. and Bank of America Corp. Below, you can see the recent sector rotation, depicted in the asset flows within the Select Sector SPDR universe of exchange-traded funds.

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ETF sector inflows

So, what accounts for this repositioning of assets? In large part, the Fed’s accommodative monetary policy, together with rising inflation expectations. Take a gander at the current Treasury yield curve (in purple) and you’ll see how deeply the central bank has pulled down the short end as the curve has steepened.

Treasury Yield Curve

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A steep curve allows a bank to borrow cheaply through the deposit window while it lends money out at substantially higher rates. In short, it’s a good lending environment, which is why bank stocks have historically outperformed other industry sectors as rates rise.

Banks, in fact, are driving the asset flow into the financial sector. Eighteen bank stocks populate the 65-issue Financial Select Sector SPDR (XLFportfolio, each averaging a 24% gain for the year to date. Banking is the heftiest of XLF’s five subsectors, accounting for 39% of the fund’s capitalization.

From a broad perspective, the steepening yield curve has been a good thing. A rising spread between short and long rates indicates an expanding economy and a healthy credit environment. But going forward? Are rates likely to rise further from here?

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Disclosure: Brad Zigler pens's Alternative Insights newsletter. Formerly, he headed up marketing and research for the Pacific Exchange's (now NYSE Arca) option ...

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