XLF - XLF: Insiders Are Buying Up From The Panic Sellers

2023-03-27 06:23:56 ET

Summary

• Investor panic over the banking crisis has caused a recent exodus from the Financial Sector ETF, resulting in significant underperformance relative to the S&P 500.
• However, before investors panic further, we've spotted a potential mean-reversion opportunity on the XLF that could turn things around.
• Also, financial insiders have scooped up their shares, picking up the pieces gleefully from the panic sellers.
• Despite the ongoing panic, the broad market remains calm, with credit default swaps at levels far below the panic-induced highs of the past.
• With market operators likely betting on containment of the crisis, the XLF is shaping up to be an attractive proposition for investors.

Over the past month, investors have been fed a daily deluge of news emanating from the banking crisis following the downfall of Silicon Valley Bank or SVB ( SIVB ) and Signature Bank.

The rapid failure of these banks caused consternation among investors, the US government, and regulators about whether the contagion could be contained effectively.

Switzerland's banking scene was also engulfed in turmoil, as Credit Suisse ( CS ) needed a government-backed bailout by arch-rival UBS ( UBS ). Investors fret worse moral hazard risks as it combines the two wealth management behemoths.

However, the Swiss government justified that CS was too big to fail. If they had let Credit Suisse collapse without appropriate government intervention, the Swiss government believes it would have "triggered major international upheaval in the financial markets." Finance Minister Karin Keller-Sutter stressed:

Doing nothing was not an option. Without a solution, payment transactions with CS in Switzerland would have been significantly disrupted, possibly even collapsed. We should have expected a global financial crisis, as the crash of CS would have sent other banks into the abyss. - Bloomberg

Keller-Sutter's commentary has likely set the stage for other government bailouts moving forward, given how these " complex and interconnected systemic troubles " could tear apart the global financial system, resulting in a potential repeat of 2008 that everyone fears.

However, the Biden Administration is likely moving cautiously to avoid portraying the notion that Main Street needs to rescue Wall Street again. The optics could be disastrous for his re-election hopes.

Therefore, we believe it possibly explains why Treasury Secretary engaged in confusing back-and-forth messaging regarding a "blanket guarantee" on all deposits. Despite that, the US government and regulators appear committed to minimizing the risks of another bank failure that could unravel recent efforts to stanch further deposits outflow, with First Republic Bank ( FRC ) in the crosshairs.

An expansion of the Fed's emergency lending facilities targeted to shore up FRC's balance sheet was reportedly among the options in a recent discussion.

In addition, the regulators " concluded the bank's deposits are stabilizing and that it isn't susceptible to the kind of sudden, severe run" that knocked out SBNY and SVB.

As such, the US government and regulators appear confident that a private sector solution could be reached to safeguard the solvency of First Republic Bank. Also, FRC and some of its peers that courted high net worth depositors will likely need to rethink their strategies after getting hammered by the " superprime banking crisis."

Even Charles Schwab ( SCHW ) wasn't spared, as investors focused on the debt securities on its balance sheet. However, the company is confident that it could " continue to operate even if it lost most of its deposits over the next year."

JPMorgan ( JPM ) corroborated the company's confidence, indicating that SCHW's " weekly inflows surged" despite the banking crisis. Moreover, it added that Charles Schwab has "virtually no risk from a bank-type run."

Also, Charles Schwab CEO Walt Bettinger put his money where his mouth is as he purchased 50K shares last week, along with other directors and executives that saw value in its stock.

Hence, are we at the start of a worse contagion that could take down the whole financial sector? Does the data show anything meaningful that investors could glean?

Interestingly, hedge funds have moved their "attack" on Deutsche Bank ( DB ) this week, " ratcheting up their bets against the bank in the stock and credit-default swaps markets."

However, the German government quickly declared its public support for the bank. Chancellor Olaf Scholz called it a "very profitable bank" while stressing that the European regulatory regime is robust and stable."

Despite that, banking investors should know that a crisis of confidence is very damaging. Credit Suisse's rapid collapse highlighted that even a globally systemically important bank or G-SIB would not be spared if the market moves against you in droves.

Therefore, we are standing at a critical juncture now as investors parse whether there are attractive buying opportunities in the US financial sector.

While the word crisis carries a negative connotation in English, it's less negative in Chinese. The Chinese word for crisis is "Wei Ji." Wei indicates adversity, while Ji represents opportunity. As such, crisis, or Wei Ji in Chinese, reminds investors that adversity also presents hidden opportunities to capitalize.

With that in mind, we believe investors must note that they don't have to undertake company-specific risks to participate in the banking crisis if they don't wish to.

A blow-up like SVB or SBNY cannot be ruled out, as regulators and the US government have clarified that even if they save the depositors, they would likely leave investors and owners in the lurch.

In addition, the significant markdown suffered by Credit Suisse investors in the aftermath of the bank's bailout is another reminder that company-specific risks are high and should not be ignored.

However, it's also important to note that credit default swaps are nowhere near the highs in the pandemic panic of 2020. Hence, the market has not gone into a panic frenzy, as the steep selloff in the S&P 500 ( SPY ) ( SPX ) was very much contained within the financial sector ( XLF ) for now.

As seen above, the price action in the XLF/SPY has taken out the lows over the past two years, opening up the possibility of a potential bear trap or false downside breakdown.

So, how have the financial insiders reacted to the recent selloff?

We noted that the XLF Insider Buy/Sell ratio has surged. While it's still below October highs, it's clear that financial insiders have also joined SCHW management in buying up their shares.

Backtesting data suggests that the level of the recent XLF insider buy/sell ratio is consistent with "high win rates for the two to 12 months timeframes and exceptionally high median return for 12 months (+34.95%)."

Hence, these insiders are not rushing for the exit, which would have been the case if they had expected a financial meltdown to occur.

While they could be wrong, it's also important to note that these insiders picked up their entries with remarkable precision during the pandemic panic of 2020, the Eurozone debt crisis of 2011/12, and events leading up to Brexit in 2016.

While the level of pessimism has yet to reach those levels, we believe XLF's panic-selling price action is consistent with the buying fervor seen by the insiders.

Hence, while panic sellers "sell first and ask questions later," insiders leveraged the opportunities to pick up the pieces from those who fled.

As such, we glean a potential mean-reversion opportunity for the XLF, as it's unlikely that the US government would allow the " entire sector to implode."

However, the price action indicating a bullish reversal has not been validated. As such, investors looking for price action confirmation will need to observe further.

Despite that, we have already taken the opportunity to start adding exposure and will move even more aggressively if we observe a bullish reversal price action.

Rating: Buy

Important Note: Investors are reminded to do their own due diligence and not rely on the information provided as financial advice. The rating is also not intended to time a specific entry/exit at the point of writing unless otherwise specified.

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