Bubble Exchange: Technology vs Financials

• Posted by DynamicHedge
• on March 13th, 2013

This is not an overarching model for modern markets, just shining the spotlight the relative performance of two sectors that have flipped between been perceived as the new-new thing and and old-man boring by two distinctly different groups of investors at two distinctly different periods of time. Maybe it will give some perspective.

Advocating the leadership of Financial stocks is probably one of the most unpopular themes I floated last year. No one liked the idea of zombie banks leading the market higher after the pain they inflicted on the economy. Almost poetic that the most hated sector would lead the most hated rally of all-time.

There is an argument to be made that if they’re to return to historically mean-reverting levels, then positive performance should continue. On a relative performance basis, financial stocks are still deeply discounted to almost everything. Regulatory risk and general uncertainty of the role of financial institutions going forward are both cited as part of the discount, but I think the real fear is that every dollar of earnings has a dollar worth of “shadow risk” because banks are likely to go back to their old ways and blow us all up again if given half a chance. Is it possible that we are overemphasizing the perceived risks after most bad behavior has been exposed in the wake of the financial crisis?

Lack of closure to the financial crisis means participants feel a lack of justice.  Lack of meaningful punishment means fear of recidivism. How deeply do these factors deserve to be discounted?

I never advocate buying the laggards in the short term — always stick with the winners. In the long-term, it’s a different story; mean-reversion and spotting emerging unloved trends work very well depending on your skill set.

I’m well aware that the cycle I’ve illustrated indicates that we should have another crisis right on deck, but the market is not predictable enough for that meme to play out again. Instead, I expect this relationship to normalize.  Financials have strong relative-strength in the short-term and are still deeply discounted in the long-term.  In order for this spread to normalize financials have further upside or tech falls apart (unlikely given that tech is relatively fairly valued).  Given that financial stocks are still so deeply despised, I feel the higher probability is that they move the spread more by continuing to appreciate.  Tech took a long time to come back after the bubble burst, s don’t expect this relationship to resolve in the immediate future.  Keep an eye on the spread and don’t count financials out just yet.

 

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