In short: The financials leg of the holy-trinity sector portfolio, "the top three sectors" this summer. He would maintain the allocation.
Financials (banks, insurers) complete the holy trinity. He gives no separate thesis for them in this interview beyond noting that the three-sector portfolio "has done superbly" and that he would keep it.
47:36So gold, commodities, crypto. And then at the sector level, I go back to a portfolio we launched about four years ago, which was this holy trinity idea: healthcare, energy, financials. It's done superbly since we launched it, and this summer I'm proud to announce that these are the top three sectors.
In short: "Everyone on Wall Street is massively long the financials here." Buy a one-year put on XLF with 1–3% of the portfolio — vol on the financials is cheap and they get "really hammered" if yields break out.
XLF is the main fund tracking US financial stocks — the banks, brokers and insurers as a group. This is his hedge of choice for a market correction.
The case has three legs. Positioning: "everyone on Wall Street is massively long the financials," priced for Fed-appointee-and-deregulation good news that has been public for two years. Valuation: record price-to-book on the biggest banks. Hidden exposure: the off-balance-sheet loans to data centers, plus mark-to-market losses on the long-dated corporate bonds they hold.
How he'd do it: buy a one-year put option on XLF — a contract that pays off if the sector falls, costing only the premium — sized at 1–3% of a portfolio. Options on banks are unusually cheap right now, which is the whole reason the trade is attractive.
36:25That's my point is it makes some sense to maybe take one to two percentage of maybe three percentage of the portfolio and either raise cash or have some hedges through long-term puts on the financials which would get really hammered in that kind of dynamic.
In short: Favorable, and the explicit destination of the rotation out of interest-sensitives: "go into a sector like financials that as long as the yield curve is steep are beneficiaries."
XLF is the banks, brokers, insurers and payment companies of the S&P 500. It is on Schwab's favorable list, and it is also where she says the money leaving utilities and real estate has actually gone.
The mechanism is the shape of the yield curve. Banks borrow short (deposits) and lend long (mortgages, business loans); when long-term rates sit well above short-term rates — a "steep" curve — that gap is their profit margin. Rising long yields hurt anything that behaves like a bond, but they hand banks a wider spread, so the same force that is punishing utilities is paying financials.
42:53You've got balance sheet oriented factors, strong free cash flow, high interest coverage. And there's been more consistency in outperformance and underperformance when you look at the factor level than there has been at the sector level, which is much more monolithic. So we do have a bit of a cyclical bias in terms of the sectors that we have more favorable ratings on industrials, materials, financials.
In short: "I'm overweight the financials. I think they do [keep going]." The driver is the curve: Warsh's removal of forward guidance anchored the front end while the long end presses up, "starting to steepen out pretty dramatically." History rhymes — 2013's taper tantrum, post-2016 — "whenever we see a big steepening in the yield curve and rates start to creep up, that's generally been very constructive for financials… banks borrow short, lend long."
This is Newton's clearest overweight, and it rests on one mechanism: the shape of the yield curve. Banks make money by borrowing short-term (deposits, on which they pay little) and lending long-term (mortgages, corporate loans, at higher rates). The gap between those two rates is their profit margin — "net interest margin."
Right now that gap is widening. Fed Chair Warsh has stopped giving "forward guidance" — advance signals about future policy — which pins short-term rates in place, while long-term yields drift up on stronger growth and higher oil. Short rates anchored, long rates rising: the curve "steepens," and bank margins widen mechanically. Newton points at 2013's taper tantrum and the months after the 2016 election as the same setup producing the same result.
The extra nuance he adds is important: the steepening is partly driven by better growth expectations rather than only by inflation fears. Rising long rates for a good reason ("if the yield curve can push up because of growth") is a far better environment for banks than rising rates because investors are worried about the government's finances.
The move is also broadening inside the sector — from the investment banks (Goldman, Morgan Stanley) that led first, out to the deposit-taking lenders (Bank of America, Bank of New York, Citigroup) that benefit most directly from the margin.
21:48I believe it's up 20 or 25% on the year. Trading at all-time highs. But, what's your view on the financials here? Do they keep going? — I'm overweight the financials. I think they do. Specifically because of what Warsh's stance [as heard: "war chest stance"] and the Fed's stance towards forward guidance has done to the yield curve and starting to steepen out pretty dramatically in the last few weeks.
In short: "We're seeing a lot of clients short the financials, either short puts on the XLF" — the expression of the credit-crisis call for later in the year (his wording on the option leg is ambiguous; the trade is bearish the sector via XLF options).
XLF is the fund that tracks the big US financial stocks, and it's how his clients are betting against them: "we're seeing a lot of clients short the financials, either short puts on the XLF." (His phrasing on the option leg is loose; the position is bearish the sector, expressed through XLF options.)
The logic: a credit crisis that starts in private credit and AI-related software lending eventually reaches the banks that funded it, and he expects that to arrive later in the year — September or October — just as the post-Hormuz inflation bounce lands.
24:59There's a lot of ways to short the financials, but that's where you get the credit problem later in the year because you're already seeing the credit problem in what's called private credit or the KKR private equity which is exposed as well. — Crypto is a pain. Holding Bitcoin, Solana, Ethereum means you need three separate wallets, three separate apps, three separate seed phrases.
In short: Beaten-down financials look intriguing — a multi-year breakout that corrected hard but is still in an uptrend.
XLF is the ETF for the big US financial stocks (banks, insurers, etc.). Hay likes them precisely because they've lagged and "come down really hard." They had a multi-year breakout, popped, then corrected sharply — which scared people off, even though the longer trend is still pointing up.
His rule of thumb: find sectors that are in an uptrend but have just corrected, because you get a rising trend without overpaying. Financials fit that pattern right now.
33:54— Well, I think some of these financials that have come down really hard look pretty intriguing. — Yeah. — So that mean they've been lagging the market and they did have a pretty good breakout. And so a lot of times what happens when you get a multi-year breakout is there's an initial pop and then a correction and it caused people to give up on it, but it's still in an uptrend.
In short: Recommended shorting the financials (private-credit exposure + AI/software disruption — "two punches"); now deeply oversold below the 50-DMA.
XLF is the main fund tracking U.S. financial-sector stocks (banks, insurers, etc.). McDonald recommended betting against (shorting) the financials.
His reasoning is "two punches at once": banks are exposed to the brewing private-credit mess, and they also face disruption as AI hits the software companies they've lent to. The group has underperformed the S&P by the most since the 2008 crisis — though it's now so beaten down it's deeply oversold short-term.
3:56In other words, there's a lot of oversold stocks in the financials right now. Mhm. On the private credit front, because you did mention Lehman, so you're getting a lot of questions. Do you think it's this cycle's subprime? It is this cycle's subprime. One of the best credit investors that I know, I had dinner with them.
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