Stock Market

Instead of tech stocks, consider regional bank stocks for a contrarian trade.

The big picture idea? Regional banks have suffered due to negative sentiment while tech has been the beneficiary of all the stock market optimism. This extreme dynamic will eventually correct, and regional bank stocks will return to their long-term average prices. The question of course is when. I think this will happen sooner than later. Why? Because the banking sector’s reaction to some scary news may indicate that better times are ahead for those stocks.

In case you missed it, a note released by the Federal Deposit Insurance Corporation (FDIC) recently received a lot of attention on social media as it revealed that that the number of “problem banks” – those with assets, liabilities or financials that make them susceptible to insolvency – had increased from 52 in the quarter before to 63. That’s more banks experiencing problems than at any other time over the past 10 years. These banks have unrealized losses of $517 billion.

The source of these losses is clear. It stems from these problem banks buying longer-term bonds that paid higher coupons than shorter-term bonds. Banks took on longer durations when the Federal Reserve was cutting rates, a trend the Fed viciously reversed with its rate-hiking cycle. Those losses in long-duration Treasurys are a direct consequence of Fed policy.

This inherently is what sparked the collapse of Silicon Valley Bank, Signature Bank and Republic First Bank. It’s all the same issue. The interesting thing is that regional bank stocks didn’t really respond that negatively to the latest FDIC news. And with Treasurys holding up well, bank stocks might have a lifeline.

Last year I argued that to save banks, you need to break stocks to force the flight-to-safety trade back into Treasurys and fill the hole of the losses that these institutions have suffered. Even if this doesn’t happen, a recovery in Treasurys should provide a tailwind to regional banks.

I maintain the idea that these stocks are a contrarian play that can work well if the trade is structured as a pairs trade against tech (i.e., for every dollar you are long regional bank stocks, you are short a dollar on tech stocks).

If tech falls, the market falls. If the market falls, I suspect that Treasury yields fall. And if Treasury yields fall, then that should cause a real opportunity in regional bank stocks.

On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

The Lead-Lag Report is provided by Lead-Lag Publishing, LLC. All opinions and views mentioned in this report constitute our judgments as of the date of writing and are subject to change at any time. Information within this material is not intended to be used as a primary basis for investment decisions and should also not be construed as advice meeting the particular investment needs of any individual investor. Trading signals produced by the Lead-Lag Report are independent of other services provided by Lead-Lag Publishing, LLC or its affiliates, and positioning of accounts under their management may differ. Please remember that investing involves risk, including loss of principal, and past performance may not be indicative of future results. Lead-Lag Publishing, LLC, its members, officers, directors and employees expressly disclaim all liability in respect to actions taken based on any or all of the information on this writing.

Michael A. Gayed is the Publisher of The Lead-Lag Report, and Portfolio Manager at Tidal Financial Group, an investment management company specializing in ETF-focused research, investment strategies and services designed for financial advisors, RIAs, family offices and investment managers.

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