The Hidden Reason Why Bank Stocks Could Tumble
Some thought the resolution to the Cyprus crisis would hurt the banks. But not bank investors.
Despite worries that bank contagion could spread throughout Europe in another banking crisis, the financial sector ETF (the XLF) has dropped only 1.5 percent over the past week and a half, and is still up 11 percent year-to-date.
But while the equities have been almost flat, the effect of Cyprus could certainly been seen in the credit market. Bond expert Lawrence McDonald notes that in the big U.S. banks like Goldman Sachs and Morgan Stanley, the credit default swap spreads—which essentially allow investors to buy protection against a bank failure—have gotten wider, reflecting greater concern around these banks.
To McDonald, this is a clear warning sign. "Credit on the big banks is a phenomenal leading indicator for the markets and the XLF," McDonald said. "When I see that the credit market is underperforming the equities, I start shorting the XLF."
Enis Taner of RiskReversal.com agrees with that bearish take. "I think the bank stocks have been way too complacent," Taner said, and the action in the credit default swaps speak to that. "The credit markets are always much more in tune with what goes on globally than the equities are, especially when it comes to financials."
The basic issue is that the credit markets are now saying that there's more risk in these banks than has previously been priced in, "and there should be a discount in the equities to reflect that extra risk," Taner said.
That's why Taner, like McDonald, likes the idea of selling the banks now.
"Banks," Taner said, "are just the wrong sector to be in."
—By CNBC's Alex Rosenberg