If This Sector Rallies, It Could Bring the Rest of the Market with It

Earnings season is here. Once again it’s all up to the banks.

The action in bank stocks tends to lead the action in the broad stock market. This is especially so during earnings season.

When the banks are strong, the market rallies. When the banks are weak, so is the stock market.

Here’s how we see things playing out…

The major money center banks like JPMorgan Chase (JPM), Citigroup (C), and Bank of America (BAC) are scheduled to report earnings starting next week. The market’s reaction to those reports will set the tone for this earnings season.

The bank stocks have sold off over the past several weeks.

The KBW Bank Index (BKX) is down 13% since early August. It’s trading near its low for the year.

So, expectations are low. Most of the talking heads on financial television are leaning bearish for the banking sector – for good reason…

Interest rates have been moving sharply higher.

Deposits have been shrinking as money moves out of low-yielding savings accounts. Loan demand has decreased. And many banks have Treasury bond portfolios that are significantly underwater as T-bond prices have fallen.

Hardly anyone is looking for good news from the banks this earnings season. And, the price of the bank stocks reflects that situation.

But, my contrarian nature has me wondering if stock prices have fallen so much that we’re due for an upside surprise.

Look at this chart of BKX…

This chart forms a “falling wedge” pattern – a contracting series of lower highs and lower lows. This pattern often forms at the end of a decline phase and leads to a reversal to the upside.

Also notice that, while BKX has made lower lows over the past few weeks, the technical indicators at the bottom of the chart (MACD, RSI, CCI) have made higher lows. This is the sort of “positive divergence” that often signals an impending change in trend – from bearish to bullish.

The upcoming earnings season could be a catalyst for that shift.

Let’s face it, most investors are not looking for positive announcements from the banks. They’ve been selling the stocks in anticipation of bad news.

So, much of the potential for bad news is already discounted in the price of the stocks. That means any hint of good news could inspire an oversold rally in the banking sector.

And if the banks start to rally, then the rest of the stock market should follow along.

Best regards and good trading,

Jeff Clark

Are you watching the earnings reports?

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