Perfect Match: Cross Border Financial Wedding Trade (TD)

A good week to all. May you profit 37 times over on all your trades this week.

A quick report on last week’s initiative before we get down to business.

You’ll remember that we went long/short using silver bullion (SLV) against the gold miners (GDX) in our May 3rd trade. Our reasoning was based on the premise that the miners had gotten ahead of themselves, pricing in a rise in the precious metals that appears now to have floundered. With that, we put on the trade and pocketed a $580 credit for our troubles.

And today?

A week later, the spread has tightened, as we suspected it would, and we’re up another $160 per board lot traded. We’re still a ways from closing the trade, though, as we expect further tightening between the two. So hold fast, and stay tuned. With help from above we’ll turn this into an outright devil of a winner!

FROM-ABOVE

We’re going to piggyback this week on an idea offered by fellow Normandian Matt McAbby in his article from last week called Seismic Market Move Imminent.

For those who can’t get enough of whipper-snapper Matt’s writings, you’ll remember that he pointed up a likely burst from the financial sector – ‘imminent’, he said, citing a technical formation he termed ‘flatlining’.

Now, we agree that the chart of the financials has a “quiet… all too quiet” look about it that speaks to a probable breakout, and we, too, believe we could see some fat gains from a trade that exploits that suspicion.

But as Matt also stated, it’s hard to figure exactly which way the financials will move. Will we see a breakdown – likely short-lived, but steep nonetheless? Or are we going to experience a meltup, completely unanticipated and therefore potentially much larger than anyone suspects?

Hmm…

Before we address how to play such a conundrum, let’s first consider 1) some broader equity currents that provide context for the trade, and 2) let’s focus on the financial sector as a whole, with an eye to selecting those elements that offer us the best bang for our buck should the trade, indeed, materialize as we expect.

We’ll start with this –

The U.S. market, despite superior economic numbers, has lagged badly behind the rest of the world’s stock indexes year-to-date.

Have a look here –

S&P - OUTPERFORMANCE

It’s a phenomenon that’s a bit puzzling, but apparently the drop in oil prices led to a good bout of nervousness stateside (and some excessive wallet-clutching), producing sub-par returns from the S&P 500 since New Years. Outside the U.S., diminished expectations gave rise to a greater enthusiasm when the worst didn’t transpire.

It’s likely a strong buck also put the chill into American investors, who expected to see deep dents in corporate profit reports as a result.

But if we focus our gaze a little further down the road, we can foresee a simple rotation in the making – a move out of those same bourses that outperformed in the first third of the year and back toward North American equities.

The flow could be significant, too, and as McAbby’s research of last week points out, it could be the financials who are the greatest beneficiaries of the rotation.

Can-Am Banking Analysis

That said, we’re going to look briefly at both Canadian and U.S. financials, those two countries possessing the worst YTD returns on stocks (on chart: S&P and TSX), and among those we expect to rebound most sharply when the cash begins to course again to these shores.

Consider the following –

BANK-PE-RATIO

The above two charts tell an important story.

It goes like this –

Canadian banks are far more closely tied to the energy sector than American – the former’s oil patch comprises a far larger stake of the overall economy than their American counterparts.

The banking sector in that country, therefore, took a bigger hit over the last year as the price for crude plummeted and dragged the broader Canadian economy into a rut.

The chart on the left shows just how much earnings multiples on the banks have contracted in the last half year, as business with the oil sector slowed dramatically. P/Es fell from 12.3 to below 11.8, putting them roughly back into line with their U.S. counterparts.

The Plot Thickens

From the right hand chart, we see something even more telling. Estimates of future growth from the American banking sector are nearly twice as high for 2016 and two-thirds again as large for 2017 than they are for their Canadian counterparts! And it’s these estimates that justify current earnings multiples.

The takeaway is that there’s very little room for error on the American side, while Canadian banks are priced far more conservatively, allowing for greater forgiveness on earnings day.

That said, we’re going to look at what we believe is the best of the Canadian banking bunch and set it against the U.S. banking sector as a whole, with an eye toward the outperformance of the former.

Which bank is best, and why is it TD?

The premier Canadian bank today, in our estimation is Toronto Dominion (NYSE:TD), with 24 million customers worldwide and a full 29% of its earnings harvested in the U.S. TD also has less exposure to the Canadian oil sector than its peers, trades with a modest P/E of just 11.08 and carries a dividend yield of 3.53%. Its technicals are also constructive.

Have a look –

TD-NYSE-TD

Coming off an oversold January bottom, TD shares rose 19% before backing off marginally last week (red circles). They now sit above the all-important137 day moving average and are encroaching upon the longer term MAs which are both still rising (red arrows). That last point is significant, as we expect them shortly to overtake them and be bolstered higher in the process.

Both RSI and MACD are above their waterlines and nowhere near overbought (in blue), providing ample support for further technical buying. In short, all systems appear to be ‘go’ for this outfit, and we should see fireworks if/as/when the stock ascends above $47.75, a 3% move from last Friday’s close that could materialize as soon as the end of the month. TD announces Q2 earnings on the 28th of May.

TD-SOLID-EARNING-GROWTH

TD’s ten year earnings record is stellar. We expect a move to $51 to materialize shortly.  So here’s how you can use a simple options to profit on TD’s outperformance –

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Our recommendation is to consider purchasing the TD October 50 CALL for $0.40 and selling the iShares U.S. Financials ETF – IYF November 100 CALL for the same price.

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Our recommendation is to consider purchasing the TD October 50 CALL for $0.40 and selling the iShares U.S. Financials ETF – IYF November 100 CALL for the same price.

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With kind regards,

Hugh L. O’Haynew

See what people are saying...

  1. Rob

    I like the work you do, however, CDN. banks are not cheap if you understand the CDN. real estate market problem that has begun and that the country’s manufacturing is being gutted to low wage states. High leverage real estate is what is keeping the economy going. Now that Alberta is going down like Texas, watch that real estate bubble affecting bank profits. People go to work in Alberta but leave go move back to where they came from when the jobs run out.Very unique situation in Canada. Why? Spend a winter there. CDN. family debt to incoe is at record levels. This a possible drop in bond prices gives us a big problem.

  2. Rob

    I just read my former comments and didn’t proof read it. Let me fix it.
    I like the work you do, however, CDN. banks are not cheap if you understand the CDN. real estate market problem that has begun and that the country’s manufacturing is being gutted to low wage states, “right to work states”. High leverage real estate is what is keeping the economy going. Now that Alberta is going down like Texas, watch that real estate bubble affecting bank profits. People go to work in Alberta but leave and go move back to where they came from when the jobs run out.Very unique situation in Canada. Why? Spend a winter there. Alberta is the ONLY province in Canada that has non-recourse mortgages. Can walk away. CDN. family debt to income is at record levels. This and a possible drop in bond prices gives us a big problem. Canadians are up to their eyeballs in interest sensitive mutual funds that are extremely over-weighted in financials and utilities, I can’t imagine what will happen when this reverses.

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