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As they were hitting new intermediate term highs, I shorted the financials yesterday via the XLF at $12.62/share.

Howard Penney will walk through the bottoms up earnings expectations embedded in Q3/Q4 for the Financials in another note. Here are a few things to consider as to why my macro models flashed sell:

  1. Spread – the yield curve’s spread is within 3 basis points of being as wide as it has ever been. Ever is a long time, and lending spreads can easily compress if the US Federal Reserve ever opts for sobriety in their analysis of Q4 inflation.
  2. Range – with GS and JPM earnings out of the way, the Financials look to be setting up to trade in a proactively predictable range. This will provide opportunities to tactically short the group on up days, and cover it on down days (my new range for the XLF is $11.56-$12.71; see chart below).
  3. Duration – as shown in the chart below, the long term TAIL for the Financials remains broken. Unlike the unlevered factors embedded in the Nasdaq, the financials need leverage and a socialized yield curve to earn a return on capital – so this makes sense.

Since the XLF bottomed on March 5th, 2009 at $6.24 we have seen a generational short squeeze that only an CNBC rockstar turned independent research analyst could perpetuate. AFTER a group rallies for a double (+102%) is not the time to get hyped up about Goldman Sachs. They are the chosen ones, we get it – but we also get that there is a time and a price for every risk managed position.

KM

Keith R. McCullough
Chief Executive Officer

US Financials (XLF): Love Me; Love Me Not? - xlf