Over at Profit Amplifier, my premium options newsletter service, we've taken a decidedly bearish stance over the past month -- even as stocks seem to be making new highs.
As I've stated in many of my alerts, I'm not bearish on the entire market... just those companies that are at risk of slowing growth or are currently overvalued.
And while I see weakness in many areas, there is one sector I believe is undervalued and could continue to flourish despite the coming volatility I've forecasted.
But before we dive into this sector, there are some important market mechanics you must understand.
At first glance, most retail investors seem to believe that the election of President Trump has lifted most stocks. While the market's general performance seems to support that theory, it couldn't be further from the truth.
Many stocks and sectors, such as brick-and-mortar retailers and energy, have had a rough go in the first half of 2017. As I write this, the Energy Select Sector SPDR Fund (NYSE: XLE) is down 13% year to date, and Macy's (NYSE: M) and many of its peers are down 40%, 50% or more from their recent highs.
So with all this carnage, how are indexes making new highs?
It all comes down to how these indexes are constructed. Many indexes -- including the Dow, the S&P 500 and the Nasdaq Composite -- are weighted so that the stocks with the highest prices (or, in the S&P 500's case, highest market caps) have a greater impact on the index's value than smaller, lower-priced stocks. That means their performance can be driven by a small number of high-priced companies.
Research cited by CNBC recently confirmed that very few of the thousands of publically traded companies are actually moving markets higher.
These forces are so strong that the Dow and S&P 500 seem completely disconnected from each other. In fact, this is the lowest level of correlation that the two have seen in more than 13 years, largely due to the fact that the Dow simply doesn't have the tech exposure that the S&P 500 and the Nasdaq have.
My point is that the market as a whole may seem like it's "winning," but there are only a handful of stocks that you should be long. It's a stock pickers market, and we need to target the sector that's next on the hotlist.
Why Financials Will Win
One sector that's been quietly catching the smart money's attention (and cash) is large-cap financials. Investors have been shifting their funds away from tech and into banks, a sector that's still relatively cheap even after their post-election run.
Bank stocks saw their best week for 2017 in early June, with many finally showing a positive return for the year. And even as these stocks move higher, analysts are piling on and recommending them as stocks to buy.
There are many bullish forces propelling the financial sector, including global growth, tons of excess capital, rising interest rates and better-than-expected effects from financial deregulation.
The latter is the biggest key to growth here... but not for the reasons you might think.
Today, these entities are much bigger, stronger and more efficient than they were before the recession. After operating in a highly restrictive environment for nearly a decade, banks have stripped out all their operational fat, cut toxic or risky assets and become lean, moneymaking machines with minimal competition. They closed hundreds of branches and transitioned to digital and mobile platforms that cost one-tenth of what it might take to staff a branch.
They're (Still) Cheap
Currently, JP Morgan (NYSE: JPM) (12 times forward earnings), Goldman (NYSE: GS) (11 times forward earnings) and many of their peers are cheap compared to the S&P 500, which is trading at 17 times forward earnings. On top of that, these financials have serious, real catalysts for growth.
What's most compelling is the fact that the sector has still managed strong revenue and earnings growth even though these regulations were in place! Bank of America (NYSE: BAC) earned 44% more in the first quarter than it did in the same quarter of 2016.
This tells me that the sector's growth could be exponentially better than most expect when the regulatory walls really come down. And even though the House just recently voted to replace Dodd-Frank, this is only the first step in a process that many believe is a "low-likelihood" process.
Since a substantial repeal is not fully baked into the price of financial stocks, we would see a major rally if the president and a Republican-controlled Congress moved forward with plans that are a party cornerstone.
And if the market stops melting higher and turns chaotic, many of these financial firms can still flourish, as they tend to benefit from volatility.
At worst, I think it's the right time to own a group of high-quality, relatively cheap stocks that are experiencing strong, organic growth. And because this will be a longer-term trade, we can set our upside higher than normal.
Rather than betting on one horse in the financial sector, I recently advised my Profit Amplifier readers to bet on the sector as a whole with the SPDR Financials ETF (NYSE: XLF). Readers of this article could do well by purchasing shares of this ETF, but rather than simply buying the fund outright, my readers and I are using my proven options system to turn an 8.4% move into a 60% gain.
That's one of the many benefits to using options the right way -- magnified profits from small moves in stocks and ETFs. Aside from this, we don't have to tie up all of our capital in this trade -- we retain the flexibility to enter into other trades should the opportunity present itself.
There's much more I could say about our process, which has produced winner after winner so far this year -- but you'll have to check out this special report if you want to know more.
This article originally appeared on Street Authority.