Trader’s Narrative

Financial stocks have been the favorite punching bag of the shorts. And no expletive does the price action justice, especially if you’ve been long any of them as I have.

The problem is that no level of oversold seems to bring in enough strong hands to give it a reprieve. It seems that ever little bounce is just another chance for the shorts to pile on.

Things have gotten so bad that only 15.22% of the stocks in the sector have buy formations according to point and figure charting (as of yesterday’s close). To find things in similar disarray, we’d have to go back to early 2000 (14%) and late 1998 (11%).

Obviously, both of those were great buy points.

What gives more impetus to the argument now is that the banks and brokers are not the only stocks that are extremely oversold according to (bullish percent charts). Pretty much everything is - with the exception of energy. In fact, the last time the bullish percent indices for this many sectors were collectively this low was in mid August 2007.

For more information, follow this link to see how I use bullish percent charts to time the market.

It’s time to take a step back and look at the macro landscape. The central banks of the world are draining liquidity out of the world’s financial markets. Yes, the very same liquidity they created a few years earlier. Of course, they don’t come out and say that they would like to now orchestrate a down-cycle. Instead they use euphemisms like ‘fighting inflation’ or ‘controlling fuel prices’.

You don’t need to do too much digging to find a long list of central banks raising their rates: Japan, India, US, the EU, Turkey, Thailand, Denmark, Norway, etc. The first sectors to feel the effects of the decline in liquidity are the banking sector and the brokers. This is because they have the most leveraged exposure to trading and finance - which depends on the amount of money sloshing around the world. As you can see from the charts, these sectors don’t look too healthy right now:

The Securities Broker Dealer Index (XBD) has definitively broken its intermediate uptrend and has support at 175 and then at 150. Take a look at some of the individual stocks: MS, LEH, GS, MER and you’ll see some horrible, horrible charts.

Until today’s close, the banking sector was actually holding up well relative to the rest of the market. But it has now cut through the support of the intermediate trend line and the support at 108.

Something else which makes me doubt the health of financial stocks is the bullish percent in the sector. It stands now at 64% with a lot more room to fall before it reaches any real oversold level. As well, the internal breadth of the sector does not come even close to showing an exhaustion of sellers. About 60% of the component stocks in the Select SPDR Financial ETF (XLF) are above their 200 daily moving average. If or when this approaches the 30s we might start looking for a bottom.

I’m not throwing away the intermediate bottom thesis yet but I’m beginning to understand how there might be a change in the tide of the market. We will of course still have many chances to profit from bounces from oversold levels, but going forward, the tone of the market may be changing.