Banks The Cheapest Versus Overall Stock Market In 40 Years

Banks The Cheapest - Mixed Monday Action

Banks the cheapest - Following the volatile Friday action, the stock market was mostly flat on Monday, with small caps outperforming. Those who thought the stock market would continue its weakness were mistaken as the market recovered late in the day.

Most discussed topic among investors was the yield curve inversion. Inversion will hurt lending, but it won’t immediately catalyze a recession. Fears about the yield curve hurt stocks in Q4, but that wasn’t the main catalyst of the mini-bear market. Catalysts were the trade war, slowing growth, and the hawkish Fed.

S&P 500 fell 8 basis points, Nasdaq fell 7 basis points, and Russell 2000 increased 0.46%. Small caps had been underperforming the overall market for the past few weeks as the ratio between the Nasdaq and the Russell 2000 hit its highest level in 18 years. 

CNN fear and greed index was at 56 which signals greed. It fell 3 points on Monday. It’s good to see this index get back near neutral even though the S&P 500 is less than 2% away from its recent high. Friday’s decline was similar to the cumulative losses in the 5 day losing streak earlier this month.

Banks The Cheapest - Sector Performance

Since the S&P 500 fell modestly, most sectors fell. The worst 2 sectors were technology and the financials as they declined 0.4% and 0.39%. Apple stock fell 1.21%. I’ll review its announcement later in this article. The banks are underperforming because economic growth is slowing, yields are falling, and the curve is flat as a pancake.

As you can see from the chart below, the historical relative PE of the bank stocks is 57%. That's below the long term median of 76% and near the 40 year low. 

This chart makes it look like the relative valuation will bounce back. However, it also makes it look like there will be a recession soon. We could see a recession where the banks outperform as the yield curve steepens. However, the bank stocks would still fall. The 2007 area isn’t a great data point because the financials were at the heart of the economic crisis.

Best 2 sectors were the industrials and consumer discretionary which increased 0.56% and 0.24%. The utilities increased 0.12%, meaning they underperformed consumer discretionary stocks which is a good sign. However, the utilities are still up 12.56% on the year which is better than the S&P 500 which is up 11.63%.

Consumer staples fell 1 basis point. As you can see from the table below, in the past 2 post inversion regimes, the consumer staples sector outperformed the S&P 500 by 27.6% and 20.42%. Staples stocks still fell just like rest of the stock market. If you think the yield curve is about to steepen because of a recession, you could buy staples and financials while shorting discretionary. 

Personally, I don’t see the curve steepening yet. It usually stays inverted for a few months.

Banks The Cheapest - Big Apple Announcement

Apple announcement on Monday was the official starting point of Apple’s foray into services over hardware. Apple has had services such as Music already, but this was a giant leap in that direction as the company tries to monetize its users further. It knows the smartphone market is saturated. Instead of coming up with a new hardware product like it has in the past, it wants to expand its monthly subscription business. 

Selling subscriptions is a better business model than selling hardware because the revenue is consistent and switching is tough. Services also further ingrain Apple hardware users into its ecosystem. As you can see from the image below, Apple significantly expanded its portfolio of services on Monday, and has hundreds of millions of potential customers to sell them to.  

Apple announced a credit card in partnership with Goldman Sachs. The card offers 2% back on all purchases if used with Apple Pay and 1% back if used with the titanium credit card it unveiled. Purchases of Apple products get 3% back. 

Banks The Cheapest - Apple Pay has 10 billion cumulative transactions

This expansion is forward vertical integration. Apple is utilizing its power to make money on all transactions, without taking the financial risk. It’s a great brand extension. I don’t see why this card is better than some other credit cards, but Apple’s ecosystem integration will get device owners to use it even it doesn’t offer better rewards than many other cards.

Apple Arcade is an ad-free subscription service which will give subscribers access to over 100 games. Instead of just hosting games on its platform, it will be making money on a subscription just like its Music service.

Apple News+ is a service that includes 300 magazine subscriptions for just $9.99. For those investors who want the Wall Street Journal’s financial reporting, you still need to subscribe to the newspaper on its own because only articles for the general reader such as national news, politics, sports, and leisure will be included in Apple’s service.

Apple TV Channels is a hub for video subscription services like HBO, Starz, Hulu, Prime Video, and Showtime. Netflix isn’t included probably because it is a competitor. Apple TV+ is the paid original movies and TV show competition with Netflix. Apple is reported to be spending $1 billion on its own content. 

Big Hollywood names in its programming include Oprah, Jennifer Aniston, and Steven Spielberg. If I was an investor in Apple, I’d be nervous about this turning into a money pit. I think this is the biggest risk out of the announcements.

Banks The Cheapest - Apple Extends Profit Machine

In summary, Apple knows that there will never be another hardware product category that can drive profits like smartphones. However, even though smartphone sales have peaked, the time people spend on them is increasing. Therefore, the next area of profit growth is monetization of services. 

Since Apple controls the devices, it has a huge competitive advantage in selling these services. Spotify complains Apple has an unfair advantage because it keeps changing the rules on the App Store and takes a 30% cut on subscriptions made through the App Store. Apple is in a great situation in that even if users chose Spotify over Apple Music, it can still make money. The biggest risk is an antitrust lawsuit. 

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