KBE - KBE: Don't Be Fooled By The Bounce There's Still Trouble Here

2024-01-21 22:19:45 ET

Summary

• I'm kicking KBE "off the island," which is my 100 ETF watchlist.
• Regional bank stocks have rallied after a crushing last March, but there's too much risk of a second shoe dropping here.
• This might not be a Bear-Stearns/Lehman 1-2 punch, but I remain skeptical that the fundamental issues for this segment of financial stocks are over.

As I have mentioned in my recent articles, I find most areas of the market to be overvalued. That doesn't mean they will "crash" any day soon (though that's always a possibility). But what it does is make everything I analyze subject to a higher-than-normal level of scrutiny. And I have a high level of skepticism to begin with!

I followed the SPDR S&P Bank ETF (KBE) in my ETFyourself.com 100 list because it would be a good way for me to gain tactical exposure to the Financials sector, and not be limited to the more traditional large-cap financial stocks. I've owned it in the past. My goal is to have a variety of ETFs on hand so I can create a diversified portfolio that will perform well in a variety of markets and add in these tactical bets when it's time.

I don't own KBE now (which worked well for me during the regional bank drop in 2023!) I decided to give KBE a look now in the hopes there might be some value here, fundamentally and technically. I ended up disappointed. I am in the process of considering whether to remove it from my 100 ETF list and replace it with the more concentrated iShares Dow Jones US Regional Banks Index Fund ETF, which I'll write about soon.

KBE was ravaged in March of 2023, falling 25% in 2 weeks as it was right in the crosshairs of what turned out to be a flash crash in regional bank stocks after a couple of them failed. But the Fed came to the rescue and all was forgiven. The ETF rallied back to its pre-March highs, only to roll over for the past 4 weeks. That indicates to me that KBE, like much of the US stock market, had a nice bounce, but the damage is likely not done.

I rate it a Sell, as I could easily see it in the $35 range before too long. The upside potential is always there, as it is for any security. But it is an uphill battle here in early 2024. The chart below shows technical support at that $35 level, but I think in a market panic, i.e., a second round of bank-related fears, that level could only be a temporary stop toward lower prices for KBE.

What's in this bank ETF?

The basics of KBE are that it should provide exposure to the S&P Banks Select Industry Index, which includes banks within the S&P Total Market Index. The S&P Banks Select Industry Index includes financial stocks across all cap sizes in the S&P Total Market Index vs. just the larger cap companies within the S&P 500. I like finding to find exposure that it's just replicating what I am already getting in a SPY allocation. This index and KBE are both equal-weighted indices.

KBE has approximately $2 billion in AUM and $2.9 million in average daily trading volume, so it is sufficiently liquid for many investors. It has lost a lot of AUM in the last few years ($1.2 billion) as money poured out of anything with bank exposure. This is a situation that started well before the regional bank collapse just under a year ago since that was preceded by a host of Fed rate hikes.

And frankly, that's likely what caused regional banks to be so vulnerable, since their ability to loan was curtailed and they tend to carry large amounts of exposure to long-term bonds. Those factors have not changed much since last March, and the price of KBE rallied nearly 50% from its May lows. So it seems clear that the price is way ahead of the fundamentals.

KBE: "diversified," but not when they all have similar risks

There's a song that goes something like this: "I've got 99 problems but...ain't one." KBE reminds me of that. It has 92 holdings, but they all have similar issues, in that they all have the same core business: lending. They don't have the mass of the "too big to fail" banks, so they can easily see a flood of customers leave them for those bigger banks on a flight to safety. This was the case in 2008-2009 and temporarily in 2023. It is an ever-present risk.

So KBE is not a "diversified" ETF at all. That is ideal when I see longer-term opportunity, rather than what we just had, which is panic selling, followed immediately by greed/speculation. Now that bears and bulls have had their say, I'm saying stay away for now.

KBE is a mix of companies involved in asset custody, diversified, and regional banks, along with asset management firms, and financial service and mortgage finance companies. Those 92 stocks are equal-weighted, which is helpful in risk management if owned, but not when the market just showed us that the entire sector can quickly be viewed as one. I generally lean towards ETFs with a higher concentration in their top holdings.

A bet on regional banks, at a bad time to bet on regional banks!

KBE is technically not 100% in "regional banks" according to SSGA's industry allocations. However, the correlation between that and the other sub-segments of financial services is strong. KBE's performance is driven by regional banks.

Overvalued following a strong price rebound

Recent market performance has led to extended valuations across most stocks and ETFs I am reviewing, and I am having a hard time justifying stock prices across the board right now. Sure, the trailing PE is 8.9 which is attractive at first glance. But who can trust earnings going forward? Not me. It is the overhang of uncertainty that makes me, a guy who started managing his first mutual fund in August of 2008 (look up that era!) unwilling to seriously consider KBE until there's more evidence that there won't be another shoe to drop in that industry.

This chart sums up my concerns. Banks aren't lending. Banks profit on lending. Regional banks suffer from this more than big banks because big banks have other big sources of revenue, while regional banks are highly focused on their local communities and relationships. All of that took a step back last March, and the rebound in the price of the stocks in KBE has just made them overvalued again.

The charts below show 2 things: net-net, KBE has been a laggard, and that explains in part why its PE is still so low. Note I did not say "attractive!" Also, the longer-term price chart (second chart below) shows that KBE has done what much of the non-FAANG stock market has in the past few years: not much.

Conclusion

KBE is a Sell, and it is likely to be "kicked off the island," which is my 100 ETF watchlist. Risk management comes first for me, and there are too many other places to hunt for alpha.

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