Earnings season kicks off next week, and as usual, the big banks lead off. Here’s what the tape is telling me going in: for the past four weeks, financials’ relative rotation versus the broad market has been improving.
Information technology — the market’s leader for as long as anyone can remember — flattened out four weeks ago and has been weakening over the last three. Relative strength doesn’t arrive overnight; it tends to develop over time, and sometimes it provides false signals (watch the accompanying video, and I’ll show you what I mean). But capitalizing on it does require some anticipation and potential catalysts, and we’re about to get a few.
The Financial Select Sector Index trades at roughly 15.5 times forward earnings — about a turn and a quarter cheaper than where it stood in 2024. Is that the cheapest financials have ever been? No. But this is a group that has tripled adjusted earnings per share over the past decade. If forecasts get marked up following this season’s results — and improving credit, capital markets activity, and net interest dynamics suggest they could — that multiple looks increasingly attractive.
The hot trade over the past two years has been AI, and as we’ve seen, it’s a stock-picking exercise. You have to identify the winners and losers. Broadly, of late, hardware’s been the winner, and software and services have been the losers. Financials, meanwhile, are a bit simpler: if the economy is doing well, they generally are too.
Technology’s AI narrative requires you to correctly handicap which companies will capture the spend, how big it will be, how long it will last and if it can be successfully monetized. Financials don’t ask that of you. They’re a levered play on nominal growth itself. You don’t need to identify the winning horse, or harder still, find the needle in the haystack; just own the haystack.
What makes this actionable now is that the implied correlation is historically low. I’ve mentioned implied volatility before, which is the way options traders think about the options price. Implied correlation is how options traders think about the price of options on baskets of stocks relative to the price of options on the stocks in those baskets. When “implied correlation” is high? That just means option prices on the baskets are high relative to option prices on the stocks they contain. When implied correlation is low? Just the opposite is true. Put simply? Options on NDX, SPX, and sector indices are a better deal than options on single stocks.
Financial Select Sector SPDR, YTD
Because options premiums are cheap on baskets, this is a moment to buy options outright on ETFs rather than reflexively spreading them off or trading single names. With XLF trading around $55.50, the August 56 calls can be purchased for roughly $1 — under 2% of the ETF’s price — for six weeks of exposure spanning the heart of earnings season.
