My Best in Breed (BIB) system I showed you last week is as simple as it is elegant and powerful.
I look at sectors that are outperforming and then find the high-flyer stocks within those sectors. In short, I find the strongest stocks in the strongest sectors.
The inevitable result: total market outperformance. All four of my "Best in Breed" picks so far have beaten the markets' gains since I recommended them, and all four are on track to hit my targets.
Of course, I'm doing this to help you make money, so I want stocks that I feel will continue to outperform.
That's where the BIB system shines: I've developed a unique set of indicators - including technicals, short interest, and other proprietary indicators - that tell me which stocks are more likely to break out and maintain their momentum.
With that in mind, I've been very bullish on one special segment of the financial sector.
Here's the move...
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Big Banks Are Dragging Down the Indexes
Now, we know that large financial institutions have had a rough time in 2018. The "Too Big to Fail" crew is drifting around rudderless. So much so that the large-cap SPDR Select Sector Financial ETF (NYSE Arca: XLF) is in negative territory for the year. And lagging big banks are why the S&P 500 is trailing behind both the Nasdaq and the small-cap Russell 2000 this year.
On the extreme opposite end of the spectrum, smaller regional banks represented by the SPDR S&P Regional Banking ETF (NYSE Arca: KRE) are benefitting from the higher interest rate environment.
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This is due to the positive effect that interest rates have on their balance sheet operations versus larger banks that are more dependent on business activity to drive revenue. The chart below underscores the huge advantage these smaller banks have enjoyed this year.
My analysis of KRE shows that 84% of its component stocks are trading above their respective 50-day moving averages. That's the second-highest percentage of the major exchange-traded funds (ETFs) I track - the "Best in Breed."
What's more, the composite short-interest ratio for KRE's component stocks is a robust 6.3, fourth-highest among the sector ETFs.
Those numbers tell me that KRE's technical strength should continue, as stocks trading above rising 50-day moving averages tend to move higher.
And, as we've seen so often recently, the high short interest is bullish because heavily shorted stocks will benefit from a short squeeze as they move higher. That's because the shorts are forced to cover their positions by buying stock.
The next phase of my BIB analysis is digging into KRE and looking for the best of the best. Two names popped up on my screen. Both are outperforming KRE, both are making a run at all-time highs, and both should benefit from high short interest. Let's take a closer look.
First up is Texas Capital Bancshares Inc. (Nasdaq: TCBI), a regional bank with offices in, well, Texas' large cities. Texas Capital has been in a solid uptrend since September, gaining more than 40%.
For 2018, the stock is up more than 12% - that's close to three times better than the S&P 500.
Texas Capital's chart shows the stock rebounding off its ascending 50-day moving average after pulling back from an all-time high in mid-May.
The stock's nine-month rally has been marked by a series of higher highs and lows, and the current uptrend of support is looking to take out the May high.
The rally should be fueled by short covering as TCBI's short-interest ratio is a healthy 7.3 (I consider a ratio above 6.0 as excessive and likely to produce a short squeeze).
Also, just five of 18 covering analysts rate TCBI a "Buy," leaving ample room for upgrades should the uptrend continue. I'm targeting an initial move to $103 in the short term.
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Next is San Francisco-based First Republic Bank (NYSE: FRC), which operates more than 70 banking offices in higher-income locations on both U.S. coasts.
The stock has been on a solid two-month run, gaining more than 13% off an April low, with lots more room to run.
The current rally has pushed the stock above its 50-day and 200-day moving averages, trend lines that bullishly crossed last week. What's more, both moving averages are now trending higher - solid evidence for the bullish case.
Like Texas Capital, First Republic has high short interest and a clear lack of confidence within the analyst community.
The short-interest ratio is an eye-watering 13.0, a clear sign that there is pent-up buying power waiting for the shorts to begin covering their losing bets.
And nine of 22 covering brokerages are in the "Buy" camp for First Republic, meaning that the stock should benefit from upgrades as analysts jump on the bullish bandwagon. I'm looking for the stock to smoke its October record high above $105.
There's no doubt: First Republic and Texas Capital are in rally mode, propelling KRE to a "Best in Breed" position among the SPDR sector ETFs.
That's all good, but it's the underlying (and, I've got to say, baffling) skepticism among the short sellers and analysts out there that should keep these stocks headed higher.
Now's the time to jump into these "Best in Breed" stocks - before the doubters realize the error of their ways.
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About the Author
Chris Johnson (“CJ”), a seasoned equity and options analyst with nearly 30 years of experience, is celebrated for his quantitative expertise in quantifying investors’ sentiment to navigate Wall Street with a deeply rooted technical and contrarian trading style.