Banking on a breakdown?

●Financial stocks have underperformed this year despite high expectations

●Many bank stocks have recently fallen to new lows

●BAC has approached a notable retracement level

It was just around this time last year that financial stocks were widely cited as a good bet to stay on a bullish track (after outperforming in both 2016 and 2017), thanks in part to the proposed tax code revision and a rising interest rate environment—both of which came to pass.

So much for logical arguments.

To say that financials have had a bad year doesn’t exactly require a spoiler alert. Year to date, financials are toward the bottom of the S&P 500 (SPX) sector performance list, and the banking industry is at the bottom of the financial sector, down around -14% on the year.

Losses have accelerated recently, with many bank stocks falling to new multi-month lows. Bank of America (BAC) is a typical example, having broken below its late-October low a week ago and reaching its lowest point since September 2017 on Monday:

Bank of America (BAC), 2/3/17–12/12/18. Bank of America (BAC) daily price chart. Breakdown.

Source: Power E*TRADE

The latest bank downswing emerged amid a tightening of the yield curve—that is, the difference between short-term interest rates and long-term rates shrank. And because banks make money by lending at higher long-term rates and paying out depositors at lower short-term rates, any tightening of that spread cuts into their profitability.1

And not that the rising rate environment seemed to help bank stocks all that much earlier in the year (maybe it was already priced into the market more than people thought?), in recent weeks a consensus seems to have emerged that, after December’s expected increase in the Federal funds rate, the Federal Reserve is likely to slow or pause its rate-hike schedule in 2019. So, for a while at least, banks won’t have that tailwind to ride on.

The BAC daily chart shows the stock’s breakdown level (around $24.30) extends back into last year, when it was an approximate price ceiling for several months before the upside breakout and rally in October 2017 (note the stock pulled back in November 2017 to test the level as support before continuing the rally).

Now take a look at a weekly chart below, which shows BAC has just reached the 38.2% Fibonacci retracement level of its 2016–2018 rally, with the 50% retracement level looming around $22—which happens to be right around the 2017 lows that are also highlighted at the bottom of the daily chart.

Bank of America (BAC), 9/7/15–12/12/18. Bank of America (BAC) weekly price chart. Retracing the trend.

Source: Power E*TRADE

While such retracement levels are potential profit-taking targets for traders who are already in the market (in this case, traders who got short at higher levels), they also represent possible entry points for long-side traders because of the expectation that bounces or rallies could develop at these levels.

At some point banks and other financials will revert to the upside—it’s simply impossible to know when. The recent bias has been to the downside. But even traders expecting more near-term pain for banks and a decline to at least the 50% retracement/support level may nonetheless wait for the stock to bounce (perhaps a test of the recent breakdown level around $26, similar to the test of support in November 2017?) before initiating short trades. Chasing momentum can be especially risky on the short side.

Market Mover Update: Brunswick (BC) jumped more than 3% intraday yesterday, while United Health Group (UNH) gained more than 2% after forming a swing low yesterday.

Today’s numbers (all times ET): Import and Export Prices (8:30 a.m.).

Today’s earnings include: Adobe Systems (ADBE), Costco (COST), Oracle (ORCL), Ciena (CIEN).


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1 New York Times. Bank Stocks Were Bruised the Worst in the Sell-Off. Here’s Why. 12/12/18.