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Figuring Out The Way To Play Financials With Leverage

ETF Professor

The financial services sector, the third-largest sector weight in the S&P 500 is under siege thanks in part to declining interest rates.

What Happened

During second-quarter earnings season, a spate of big money center banks warned of upcoming pressure on net interest margins due to lower rates. In response, the Financial Select Sector SPDR (NYSE: XLF), the largest ETF dedicated to the sector, finished August lower by about 5%.

It's possible that the time to consider the Direxion Daily Financial Bull 3X Shares (NYSE: FAS) or the Direxion Daily Financial Bear 3X Shares (NYSE: FAZ) is drawing near. The bullish FAS tries to deliver triple the daily returns of the Russell 1000 Financial Index while the bearish FAZ looks for returns that triple the daily inverse performance of that benchmark.

Why It's Important

Obviously, August was rough on bank stocks and investors displayed little patience with the group as highlighted by $3.13 billion in outflows from XLF. That didn't mean traders piled into the bearish FAZ, which enjoyed a solid August.

Perhaps traders took profits in the bearish FAZ, which gained 6% in the eighth month of the year, because as of Aug. 29, monthly outflows from that fund stood at $6.6 million.

“However, with August in the rearview, traders might benefit from taking a closer look at exactly where the financial sector stands after the recent sell-off,” said Direxion in a recent note. “In fact, in the midst of all the trade war and global recession fears, earnings reports from the big banks revealed an industry still rolling along at a steady pace.”

What's Next

For traders tempting fate with the bullish FAS, and there have been some as that product has August inflows of $23.64 million, the success of that trade lies largely with the Federal Reserve (per usual) and investors expectations for more interest rate reductions.

“Ultimately, the fundamental statistics from the banks and the anecdotal evidence from the Fed only serves to illustrate the current business ecosystem, and can’t account for unexpected shifts in the global economy or market sentiment,” said Direxion. “But, with three more meetings planned for 2019 and an undefined course for exactly what the Fed is doing with prevailing rates, big bank investors need to contend with whether the current evidence on the financial sector’s core business strength can weather the equity market’s anxiety around business growth, global trade and whether the next recession is a few months, or years away.”

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