Trader’s Narrative

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Here’s a novel way of looking at the Philadelphia Banking Index (BKX).

Turn it upside down!

Credit: Yes and Not Yes

And voila! the parabolic move is suddenly so much more recognizable. Keep in mind the parabolic move is obvious even when the chart is logarithmically scaled. Of course, when any market trends with more and more intensity, it approaches an eventual exhaustion point. We’ve seen this in every single bubble formation - no matter what the underlying security being traded: gold, bonds, stocks, tulips, etc.

The last time I mentioned this type of technical formation was last year when we looked at the price of crude oil. The price chart of oil had the unmistakable characteristic of a bubble, taking less and less time to increase more and more. It took one more month for the oil bubble to be pricked.

The chart above would suggest that the exhaustion point for the beleaguered US financial sector is near. No one knows if what we’re seeing is yet another short lived counter rally or if it is really the blow off. What is clear, however, is that the trend has very little time left to breathe (if it hasn’t given up its last gasp as of yet).

The Question
Here’s an interesting video which covers the question on everyone’s mind: is this rally the real deal? or another run-of-the-mill bear market rally? It also uses Fibonacci levels to provide some levels to watch for next week.

The financial sector has been beaten to a pulp during this latest bear market. Every time it gets extremely oversold, it manages a feeble bounce only to dive down headfirst once again.

During the past 12 months or so the bullish percent index has jolted from one extreme to the other. According to the bullish percent index for the sector, it looks like we are setting up for one of these bounces:

If we zoom into the chart we can see things a little bit better:

And here is a corresponding chart of the Philadelphia Banking Index (BKX):

This bear market has been unusual because the financial sector has been one of the key players. In previous bear markets the banking sector has actually outperformed the general market. But obviously not only have they failed to keep up with the market lately, they have been the reason why it is dropping like a rock.

Back in May I wrote : Weak Financial Stocks May Not Hold Support Again which turned out to be right on the money.

A bit later in June I wrote that banks where broken:

…I suspect that by the time the Bank Index finds its way down to 65 or thereabouts, the bullish percent index will have commensurately fallen to significant buy areas…

The Philadelphia Banking Index (BKX) did indeed fall to 65 or thereabouts - if you interpret that liberally. In fact, the index broke 50 but when the global financial marketplace is melting before our eyes, why quibble over a few points? And the bullish percent did in fact spike to extreme oversold levels, reaching 5.62% in mid July.

These are the buy points that I’ve repeatedly mentioned and explained in how to use bullish percent to time the market. But to give you an idea of how rare this is, here is a long term chart:

Of course, what happened next is that the US government (along with a few others) decided to poke its finger in the crack of the dam and made it illegal to short sell financial stocks until October 2nd. The result of this blatant government meddling in financial markets was the two day rocket ride higher last week. To see this clearer, here is the same chart as above, zoomed in for the year to date:

Aside from the fact that whenever you get the government involved in the market it throws all technical analysis out of whack, the important thing is that before the financial stocks rallied, they had only fallen to 30% in the bullish percent index. Based on this, I suspect that had the government not banned short selling and placed a temporary, artificial floor below them, the sector would have continued to fall dramatically.

Finally, the consequence is that having meddled, the sector is now at 80% bullish percent! Which makes me queasy to even contemplate taking any new long positions. If anything, this is the sort of thin air levels at which traders start looking around for shorts. But of course, now we can’t. This is a royal mess. We’ve gone from a situation which could be analyzed to one which is totally news driven.

Paulson’s Bailout
Here’s the problem that I and many others have with the proposed bailout plan:

• the firms who are at fault face no consequences and do not give up anything
• in fact, the firms are being rescued by ordinary taxpayers who wouldn’t know a CDO if it hit them in the face
• Paulson has dictatorial power and authority for any decisions he makes
• the management who ran their companies in the ground face no consequences
• alternative plans were not presented nor considered
• there are much much better alternative plans

Raise Your Voice
Democrats have begun to push back against the scheme and I doubt that it will go ahead as presented. You can find a lot more articles about what is going on with the bailout and keep up to date by checking: news.tradersnarrative.com

I’m a Canadian so I can’t call up my representative in congress to give them an earful. But the vast majority of my readers are American so I urge you to educate yourself about what is happening. Once you realize the facts, you will understand why it is imperative that you raise your voice against the proposed bailout plan. This goes beyond partisan politics or the election. This is about the economic health of the US and the world. Do this for yourself and your children.

Today’s market notwithstanding, the financial sector has started to lead the general market once again.

Here is a chart of the Philadelphia Banking Index (BKX) alongside the S&P 500 Index (SPX):

The de-coupling started just recently but it is unmistakeable. Here is another way of looking at the relationship between the indices:

The change has just started and it is far too early to declare a trend change just yet. For that, we need to see the downtrend line broken to the upside by a continued surge in the financial sector.

But the important thing is that counter intuitively, a bull market doesn’t need the financial stocks’ leadership.

Bullish Percent
The spike low corresponds to late June, when the bullish percent for the banking sector dipped below 10% - actually going all the way to 5.62%. The last time we saw the bullish percent this close to zero was back in mid January 2008. And as far as I have data, never before!

Tectonic Shifts
This financial turmoil is unprecedented. For as far as the Philadelphia Banking Index has been trading, it hasn’t broken down this drastically. What we are seeing is tectonic shifts in the banking industry which will not only reverberate for some time to come, but it will produce a horizon drastically different from the one we knew just a month ago.

The financial sector, as measured by its proxy, the Philadelphia Banking Index (BKX) has definitely broken down. I said as much before the end of last month. While it seemed that the line everyone was watching (level 75 on the chart) might act as support, it didn’t convince me.

While it put up a bit of a struggle dancing around the line for 3 more trading days, it has now decidedly broken down:

The red line marks when I suggested that the sector would break down. The next support, as you can see, is still some way down. So I would stay away from the long side until it reaches that level.

But the good news is that if or when it does plumb those depths, there is a good chance that it will find significant support. It will be fourth time, after the 1998 LTCM bottom, early 2000 and the late 2002 bear market floor.

There is some technical support level at 70 but before a definitive bottom can be in place this sector may need to get to real support and wash out all the weak hands.

And I suspect that by the time the Bank Index finds its way down to 65 or thereabouts, the bullish percent index will have commensurately fallen to significant buy areas:

That would be, at least, a 20% points drop. Until then, while rumors like those swirling around Lehman Bros. (LEH) may fly and the negative sentiment may get even thicker than it is right now, I doubt that this sector will find its footing.

But while this may be bad news to those long banks, or other financial stocks, I don’t think that it necessarily means the market itself is somehow doomed. A bull market doesn’t need financial stocks.