Banking & Finance

Irony in Pairs: Time to Short Treasuries While Buying the Big Banks?

More than once over the past two years, the 24/7 Wall St. team has tried to identify opportunistic times to effectively short the Treasury bond market. If the horrible reaction to Thursday’s 30-year Treasury auction is any indication, now may be the time for active traders to consider being short the Treasury market.

There could be a sense of irony here too. Given the potential for the economy to show big improvement over the last half of the year, and into next year and beyond, it may also be time to buy the big bank stocks. If residential and commercial real estate lending takes off, so will the economy.

Thursday’s 30-year Treasury bond auction was met with pathetic demand due to the extremely low yield. The Treasury Department auctioned $16 billion in 30-year bonds at a high yield of 3.440%, its lowest since June of last year. The bid-to-cover ratio, an indicator of demand, was 2.09, compared to a recent average of 2.36. In fact, demand for the long-dated bonds was the weakest since August of 2011. There was also unconfirmed chatter all around Wall Street that bids from Asia were very light. If the Chinese are not buyers, then clearly this most recent and strong Treasury rally may be all but over.

The recent rally in the Treasury market started in January, when yields on the long bond were back close to the 4% level. Many components helped fuel the rally. The expectation of a still very accommodative Federal Reserve, despite changes at the top. Ongoing global geopolitical worries, which were only exacerbated more by the events in the Middle East and Ukraine. The rally also continued as the bad weather pounded much of the country and many hedge funds bet that earnings and employment numbers would be rotten for the first quarter.

While this is maybe not the entry point that the 2.50% yield was in the summer of 2012, there is a far greater possibility that the economy is on the mend. In fact, many of the firms that we cover on a daily basis are very positive about economic growth for the second half of the year. Plus, from a political standpoint, if the Republicans win the Senate in November and control both houses of Congress, that may be interpreted as bullish for business and the economy.

The vehicle we have profiled in the past to short the Treasury market is the ProShares UltraShort 20+ Year Treasury (NYSEMKT: TBT) exchange trade fund (ETF), which attempts to actually be two times short the market. While not always the most efficient ETF in the world when tracking Treasury movement, it gives traders a position and leverage with the most ease. Actually selling short a Treasury bond requires not only a borrow from your broker, which costs money, but the short seller is also responsible for paying the carry on the bond, which is the interest bond pays.

So, again, is it ironic that you could short Treasuries yet own the banks?

With all the hand-wringing lately over the so-called big rise in interest rates slowing down residential and commercial real estate growth and recovery, the analysts at RBC see the glass as half full, not empty. Rates are still at their lowest levels in decades, which makes the Treasury short make even more sense. In a new research report, the analysts are very positive on the sector and think the recovery in both the commercial and residential real estate markets is well underway, and they expect it to continue through at least 2017 and 2018. Based on past cycles, the analysts at RBC believe that there is a 41% to 46% upside potential that remains from here. They also feel that some of the top bank stocks will be big benefactors from the continued recovery. A three- to four-year impending real estate rally is hardly the data that people who own the long end of the Treasury market are hoping for.

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The RBC team points out that some banks are already seeing strong loan growth, and that others will soon be benefactors of the expected growth. Here we focused on four large cap names that are expected to increase commercial loan growth and earnings.

Bank of America Corp. (NYSE: BAC) is rated Outperform and may be the perfect contrarian pick. A huge accounting snafu hurt the stock, and the government may be looking to get another $13 billion from the bank in yet another legal settlement. Investors willing to look past the current issues may be well rewarded down the road. Shareholders are paid a small 0.3% dividend that may remain at that level due to current issues for some time. The RBC price target for the stock is $19. The Thomson/First Call consensus estimate is at $17.20. The stock closed Thursday at $14.93 a share.

Wells Fargo & Co. (NYSE: WFC) is another solid addition to the RBC list and is a financial name that may benefit if yields start moving higher. The yield curve typically steepens in an improving economy, which many on Wall Street currently anticipate. Wells Fargo is slowly, but surely becoming one of the biggest mortgage lending companies in the United States, in addition to its normal banking and brokerage businesses. An increase in commercial real estate lending could really boost the bank’s bottom line. It also remains a top Warren Buffett holding. Investors are paid a solid 2.9% dividend. The RBC price target is $51, and the consensus target is $52.04. Wells Fargo closed Thursday at $49.33.

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Comerica Inc. (NYSE: CMA) makes the list at RBC and is also rated Outperform. The company continues down a path of rewarding shareholders by returning capital. The bank’s board of directors recently announced an increased quarterly cash dividend of 20 cents per share, up 5% from the prior dividend of 19 cents. The dividend will be paid on July 1, to common shareholders of record as of June 13. Additionally, the board increased the current share buyback program by 2 million shares. That works out to a 1.7% yearly dividend for investors. The RBC price target is $54. The consensus target is $49.11. The stock closed Thursday at $47.83.

PNC Financial Services Group Inc. (NYSE: PNC) is listed as a top pick at RBC. CEO Bill Demchak recently said that for years PNC has been “planting seeds” to draw in new customers and as a result, it had “the opportunity to move these new clients toward the depth of product penetration we enjoy with our longer-term clients,” which ultimately represented “significant potential to generate new fee income.” The East Coast powerhouse should see strong loan growth in all real estate areas as the economy improves there. Investors are paid a 2.3% dividend. The RBC team has a $95 price target on the stock. The consensus target is $90.63. Shares closed Thursday at $83.86.

Is this the right time to consider a Treasury short? Nobody can say for sure, but when the directional change takes place it often happens so fast that most people will feel that they missed the boat. One thing is for sure, the Treasury market has rallied more than 15% since early January, and the economy appears to be gaining strength. Ultra aggressive traders and those who own Treasury bonds and are looking to hedge them may want to start considering putting the trade on. The combined pairs trade of owning the big banks while being short the Treasury market make even more sense for aggressive trading accounts.