How to profit from bumbling banks
Tim Bennett Jun 28, 2012
It’s been an awful few weeks for the banks. Last week, 16 of them were downgraded simultaneously by ratings agency Moody's. This week we've seen how far Barclays and other banks will go to turn a profit by manipulating the key Libor interest rate.
However amid all this carnage, there are opportunities to make money as a spread better. The key to what follows is to realise that the market often prices in bad news well ahead of it being announced. That’s because of something economists grandly call 'information asymmetry'.
In short, people on the inside of the City often know stuff before you and I do, and act on it by re-pricing shares, bonds and so on.
That sounds like bad news. But it isn’t. Typically, the market – especially in its current 'what next?' state of anxiety - will overdo it on the downside. This means shares are often marked down too hard and fast - just before in the case of Moody's, or just after the Barclays announcement. And that’s when you need to be ready to pounce.
For example, just after Moody's issued its formal downgrades, most of the big banks rose a little. The market had already priced in all the bad news and some.
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Even today, we saw a relief bounce for Barclays around 1pm as it came off lows of around 160p, as the market digested the bad news about its involvement in fixing the Libor interest rate. Regulatory announcements from the likes of the FSA are usually not leaked to anyone in advance, so the heavy selling usually occurs once the news has broken.
Now, you could try and make money from a bounce by piling into bank stocks and back out again in the cash market (ie via the shares themselves). But this is unlikely to net you much of a profit once your dealing costs are factored in.
An old market adage advises you to sell the rumour, but buy the facts. Selling ahead of an announcement is hard, as you sometimes don’t have the same information as the professionals. However, taking a long position in battered stocks using a spread bet as everyone breathes a sigh of relief (thinking “it could have been worse”) can make good sense.