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One of Wall Street’s favorite trades is unraveling this year

Some investors might wonder why regional bank stocks aren't faring better.

After all, a rising rate environment may stand to boost banks both small and large; and with proposals of deregulation in the financial services industry under the Trump administration, market strategists have widely noted the banks could soar under such conditions. But two popular bank ETFs are underperforming the broader market.

The S&P Regional Banking ETF (KRE) on Thursday posted a stellar session, rising nearly 1 percent for its best day in over two weeks. But stepping back, the ETF is up just under 2 percent so far this year while the S&P 500 has advanced over 6 percent in the same time. The S&P Banking ETF (KBE), which tracks larger banks, is up just about 2.5 percent year to date. For some context, the regional banks as a group rose 21 percent in the month following the U.S. election in November. Regional banks differ from "big banks" in the size of their operations and in the scope of their services, focusing on taking deposits, making loans and providing credit card services.

The trouble is in the yield curve, said Miller Tabak equity strategist Matt Maley. Of course, higher interest rates and a steeper yield curve — the spread between different bond maturities — tend to help the banks overall, as the institutions tend to borrow money in the short-term and lend in the long-term. A more compressed "curve" between Treasury yields would mean banks are earning less interest on loans they lend out. Indeed, Maley observed that the spread between the 2-year and 10-year U.S. Treasury notes has fallen from 1.35 percent to 1.19 percent since late December. And if the curve flattens further, "the group could break-down," he wrote.

What's more is Commitments of Traders data from the U.S. Commodity Futures Trading Commission — which can be used to measure traders' sentiment across different markets — shows far "too many" short positions on the U.S. 10-year Treasury note, Maley wrote in an email to CNBC, so it will be difficult for longer-term rates to continue to rise.

Looking at the KRE directly, Maley said the 50-day moving average is a key level of support; if the fund breaks below that technical level in a substantial fashion, that could cause some bank bulls to sell, he wrote.

When it comes to volatility and options trading in the regional banks space, Dennis Davitt of Harvest Volatility Management isn't seeing much; this is quite different from right after the election when he saw "enormous" call buying in all the banks and financials as investors priced in hopes for deregulation.

"I'm more bullish on the regional banks than I am on the big banks. Part of the reason is because the earnings that comes out of the big banks, a lot of that comes from — used to come from — proprietary trading, which is not around anymore, and it's really hard to turn that switch back on," Davitt said Thursday on CNBC's "Power Lunch."

Even if some of the big banks' activities become less regulated, the companies might have trouble cashing in.

"So I think we'll see increased economic activity, which will help both [big and regional] banks, but I think the hole is going to be in the big banks, and I think the regional banks are priced inexpensively right now relative to where the big banks are," Davitt said.

Top-weighted names in the KRE include PNC Financial Services Group, BB&T and SunTrust.




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