A New Big Bet of Mine

Financial Select Sector SPDR Fund (XLF) is up 26.7% year-to-date and is up 5.2% in October. The ETF is very large. The top 10 holdings make up almost 54% of it:

I am now short this through my ownership of Direxion Daily Financial Bear 3X Shares (FAZ), which I recently purchased. Today, I boosted it. Here is what I see going on.

XLF Has Rallied Tremendously

I shared above how much the Index ETF is up this year, and that is a slightly higher return than the S&P 500 (SPY). Looking at the last year, it is up 42%, which is way more than SPY:

Over the past 5 years, it is up a lot, but it has lagged the S&P 500:

70% is a big number! Though it is less than the overall market, it is a lot more than Small-Caps, as measured by the Russell 2000 (IWM), which is up 49%. It is up even more than Energy (XLE), which pays a big dividend and offers protection against inflation potentially.

Very recently, XLF has gapped up. Today, it opened and traded so far fully above yesterday's high, and the same thing happened on 10/11 and also on 8/15. I think these gaps could get filled. XLF, currently $47.65, could pull back to $46 for the second gap and to $43 for that second gap. I do see more downside than that.

The Stocks in XLF Are Priced Like Interest Rates Are Coming Down

Why is XLF doing so well? This month, we have seen the large Banks report better-than-expected revenue and earnings. The prices have gone higher, but they started going up ahead of the FOMC Meeting that was followed by an interest-rate cut. I wrote about this in September, suggesting that it is smart to fight the Fed right now. Rates for Treasury Securities rose sharply, as I described on October 8th. And they are even higher today.

Financials typically do well when the cost of their borrowing, short-rates, is falling. The steeper yield curve is theoretically good for them. If we go into a recession, though, they could face write-downs and losses on unpaid debt. I do include 4 banks on my watch list of personal stocks, one of which I am looking to buy (it trades below tangible book value) and three big ones, including JP Morgan and Bank of America, which are on this list. The 13PE (for 2024 projected earnings) seems low for JPM, 13.6X for BAC does too, but both of these companies traded at lower PEs last year, and neither is growing earnings very rapidly. Their dividend yields aren't that great either.

I think that investors see a better future, perhaps, as rates are going to keep coming down, but I don't think that is the case at all. I wrote about another investment idea recently, Treasury Inflation-Protected Securities, where I explained why a TIPS-virgin is hugely long the securities now (through funds and ETFs). The answer is this: TIPS are a smart way to beat inflation.

Conclusion

I own FAZ, but it is risky! I am not trying to encourage anyone to buy this or any leveraged ETF. I remain cautious on stocks, and my own outlook is that longer rates, which are already rising, could rise more. Perhaps we will go into a recession - not exactly my call yet. If that happens, XLF could get crushed. Remember 2008?