Street betting big on banks before Fed liftoff

Published Thu, Nov 12 20154:03 PM ESTUpdated Thu, Nov 12 20154:14 PM EST

Investors are betting on a December "liftoff." The SPDR S & P Bank ETF is up about 3 percent month to date and up more than 7 percent since the end of September on hopes the Federal Reserve will finally raise rates for the first time since 2006 when it ends a two-day meeting on Dec. 16. Financials should benefit in rising-rate environments as the difference between short-term and long-term rates — the so-called yield curve — steepens. Banks can then charge higher interest rates on long-term loans and borrow in the short term at low rates, generating more profit on the difference. Fed speakers hinted strongly at a rate hike this week. "I think there's a very strong case for starting the process of raising interest rates," San Francisco Federal Reserve President John Williams said Tuesday . And St. Louis Fed President James Bullard said said Thursday that zero interest rate policy has put the U.S. economy at "considerable risk of future inflation." Wall Street is getting the message and putting money to work anticipating the move... The 10 year Treasury yield increased from 2.15 percent at the end of October to 2.31 percent Thursday morning, according to FactSet. Lori Calvasina, Credit Suisse's U.S. equity strategist, wrote in a note to clients Wednesday that she is seeing more buying in financials by mutual funds and hedge funds: "Within large cap, a uniformly bullish bias is in place for banks. While structural underweights/pessimism versus the broader market have been the norm for mutual funds and the sell-side, the percent overweight and net buys are both high relative to history. In terms of trend, sell-side net buys have been on the rise while hedge fund net exposure has also been climbing and is deep into net long territory." Dubravko Lakos-Bujas, JPMorgan's U.S equity strategist, upgraded the financials sector from "neutral" to "overweight" on Thursday, seeing banks as a hedge against inflation. "The biggest driver of the outperformance (for the financial sector) will come from inflation surprising to the upside," he wrote. Here's the specific financial stocks smart investors are buying... Read More Pro Talks: Top chart analyst says market top near Some investors believe Citigroup has the most leverage to the upside. "Friday's blowout jobs number sealed the deal for a December rate hike," David Alton Clark, a top-ranked blogger wrote in a CNBC Pro column Thursday. He added, "The current quandary for investors is not whether to place a bank bet, but rather on which bank to bet. I posit Citigroup currently offers the best bang for buck of the big banks." Chris Bailey of Financial Orbit, a U.K.-based investment research firm, agrees: "Banks have been buffeted by a variety of fines and extra regulatory burdens over recent years, but mechanically ... the interest rate (hike) cycle gives greater scope to start rebuilding net interest margins. That's generally good news for the space. However the most interesting current plays have more specific drivers. Despite great progress in reducing the size of their bad bank and generally taking costs out, Citigroup's relatively high exposure to the emerging markets has weighed too heavily on their stock," Bailey wrote in an email. "(On the buying financials on rates going higher) I do agree with it. The thesis is that many financials are asset sensitive, meaning their asset yields will reprice up more than the cost of their liabilities. PacWest Bancorp and Silicon Valley Bank are a few banks that could benefit," David Schawel, portfolio manager at New River Investments, wrote in an email. Read More Goldman: S & P 500 going nowhere so buy these stocks To be sure, history has shown betting on banks before the start of a rate hike cycle isn't a sure thing. Many factors come into play besides the yield curve, such as incoming economic data and the trajectory of rate hike increases in the coming year. Using data from Kensho, a tool designed to quantify historical market events, CNBC Pro ran a study on how sectors perform during the beginning of rate hike cycles. Here are the average returns for S & P 500 sectors between the first and second rate increases in the last three Fed rate-hiking cycles in 2004, 1999 and 1994: Here is the performance of how sectors performed one month before the beginning of these rate rise cycles, which is about where we are now if the "liftoff" comes in December. Disclosure: David Schawel personally owns shares of PACW, but the fund he manages does not. And neither Schawel nor the fund have a position in SIVB. Disclosure: NBCUniversal, parent of CNBC, is a minority investor in Kensho. Disclaimer

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Investors are betting on a December "liftoff."

The SPDR S&P Bank ETF is up about 3 percent month to date and up more than 7 percent since the end of September on hopes the Federal Reserve will finally raise rates for the first time since 2006 when it ends a two-day meeting on Dec. 16.

Financials should benefit in rising-rate environments as the difference between short-term and long-term rates — the so-called yield curve — steepens. Banks can then charge higher interest rates on long-term loans and borrow in the short term at low rates, generating more profit on the difference.

Fed speakers hinted strongly at a rate hike this week.

"I think there's a very strong case for starting the process of raising interest rates," San Francisco Federal Reserve President John Williams said Tuesday.

And St. Louis Fed President James Bullard said said Thursday that zero interest rate policy has put the U.S. economy at "considerable risk of future inflation."

Wall Street is getting the message and putting money to work anticipating the move...