Trading the Bifurcated Banks
Meatloaf taught us that “Two Out of Three Aint Bad”, but the market may be taking that to an extreme.
Last week I outlined the thrill and the danger of a buy-the-rumor rally. You need to review what this signature trade looks like if you haven’t already, here’s the link.
We’ve heard very little about the risks that are still present in the regional banking sector. Banks like Western Alliance Bancorporation (WAL), M&T Bank Corp (MTB), and KeyCorp (KEY) are all sitting in the hot seat as their earnings approach.
On the other hand, there are more than a handful of companies currently sitting on the stronger side of the banking sector.
A situation like this often sets the stage for a paired or pairs trade.
For some quick background, here’s what’s involved with a Pair or Paired Trade.
The strategy involves trading two companies that are highly correlated but expected to deviate in their direction. The financial sector is ripe with companies that fit this bill.
I’ve already identified Keycorp as the bearish side of a potential pair trade. Now the bullish side.
With consumer activity remaining relatively strong, the large banks that focus on the credit card business immediately surface as bullish prospects.
Companies like American Express Company (AXP), Discovery Financial Services (DFS), and Capital One Financial Corp. (COF) hit the top of the list given their exposure to the consumer.
After a review of the charts and data, American Express presents itself as a candidate for the bullish side of this paired trade.
AXP shares are in the process of breaking to new relative highs as the stock has become a relative strength leader among the financials (and against KEY shares).
Last quarter’s earnings results -while coming in lower than expected – showed an increase in revenue of 22% as the higher-end consumers remained resilient in their spending. For the quarter the company saw revenue rise to a record $14.3 Billion. American Express also reaffirmed its full-year 2023 revenue and earnings guidance.
From a technical perspective, AXP shares are set to break out of their short-term trading range and continue their long-term trend higher. Shares are already trading above their 20-month moving average. This puts them in an elite group of financials that are trading in a long-term bull market trend.
Expectations appear to be level ahead of the earnings announcement on July 21 (this Friday) as option activity has been balanced between puts and calls. Short interest also suggests that sentiment towards AXP is at neither extreme (Optimism or Pessimism). This means that the stock is more likely to be guided by the results, not investors’ interpretations of the results.
With the stock set to maintain its leadership with a lower-risk earnings announcement on tap, and the earnings results for KEY having much more potential for a selloff, these two companies are my recommendation for a paired trade in the financial sector.
Here’s how I’m trading it:
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July 18 2023
