Credit Default Swap Spreads Warn Of Upcoming Rout For Financial Stocks (C, MET, JPM, GE, AIG)

Despite the recent upward trajectory for U.S. stocks lately, credit default swap spreads for key U.S. financial stocks soared during just the last week.

Reuters:

Credit default swaps, contracts that insure against debt defaults, are treating debt-laden borrowers ranging from Citigroup (C) to MetLife Inc (MET) as though they were rated at junk status, a sign of lingering fears of the risks of heavy debt.

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Credit insurance costs on major U.S. banks have risen by about 17 percent overall this week, according to data from Tradition Asiel Securities.

JPMorgan Chase's (JPM) swaps are up nearly 20 percent, while swaps on the finance arm of General Electric Co (GE) are up 11 percent, according to Markit Intraday.

Note General Electric is basically a financial stock thanks to its massive financial unit, whose horrible performance tanked the stock during the crisis, and is the reason the stock is still well below past highs.

Financial stocks have underperformed the market in the last month, despite past outperformance. In the last week they both underperformed and began to register negative absolute returns as well. The U.S. Financial Services sector fell 2.06% last week according to Morningstar versus a -0.66% median drop for all sectors.

The chart below shows the relative underperformance for financials on both a 1-month and 1-week time frame.

Chart

If the recent surge in default concerns for U.S. financial stocks, as exhibited by the CDS market, are valid, it could be U.S. financial stocks are just beginning to underperform the market. That's because bond holders ultimately have first claim over equity holders, thus if bond holders are worrying that their securities could be worthless, then equity holders should be twice as worried. If the CDS market moves last week are valid.

We own shares of GE and AIG, and will be monitoring the situation.

Note: The author owns shares of GE and AIG. Investors the author speaks with may have long or short positions in stocks, options, or bonds related to any of the companies mentioned.

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