On October 1, The Wall Street Journal discussed US banks ahead of the upcoming earnings season in an article titled, "Weak Trading, Mortgage Slump, Legal Costs to Cut Results at Banks.” The authors argued that expectations for positive results are limited because of a drop in mortgage refinancing, potentially declining trading revenues and rising legal costs. Should one sell banks at this point?
Looking at a price chart of the Select Sector SPDR Financial Fund ETF (XLF), it is obvious that banks have been underperforming the broader market since July. So there is a chance that a lot of negativity has already been priced in and stocks could pop even after disappointing earnings.
However, analysts' sentiment rather supports the bearish case in my opinion. Even though the WSJ article argues that “analysts are rushing to reduce estimates,” ratings still point to bullish expectations. Take Citigroup (C), which is a short position in my Covestor Technical Swing model portfolio.
Some 29 brokers are rating the stock and 21 of them have a buy rating on Citibank and only two rate the stock a sell. This leaves room for disappointment.
Don’t get me wrong: banks are not necessarily a buy, but the risk/reward for new short positions ahead of earnings is not compelling either.
Even though I am short, my goal is to reduce size or even close the position before the company releases results on October 15. “Buy the rumor, sell the fact” or better “Short the rumor, cover the fact” in this case.
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