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We’re just over one week away from the start of earnings season. So, once again, it’s time to follow the banks.
We watch the banks every quarter because the action in bank stocks tends to lead the action in the broad stock market – especially during earnings season. When the banks are strong, the market rallies. When the banks are weak, so is the stock market.
That was the case last quarter. The KBW Bank Index (BKX) bottomed in mid-March and then started to rally. The Bullish Percent Index for the financial sector (BPFINA) generated a buy signal right at the start of earnings season. And, bank stocks held up all through their reports.
That was a good sign for the broad stock market. The S&P 500 rallied from 6600 to over 7400 during the heart of earnings season.
The current setup looks different.
The major money center banks are scheduled to report earnings starting July 14. The market’s reaction to those reports will set the tone for this earnings season.
The banking sector has been rallying for the past few weeks. BKX trades about 10% higher now than at the start of June. And, that action has some financial television talking heads wondering if the banks are set to rally through the summer.
I suspect the banking sector is setting up a “sell on the news” event.
The stocks are running higher now in anticipation of strong earnings reports. Investors are discounting the good news ahead of time.
Look at this chart of the bullish percent index for the financial sector (BPFINA)…
In mid-March, the BPFINA generated a buy signal by turning higher from oversold conditions. This action helped to support a bank stock rally as we headed into the last earnings season.
Now though, the BPFINA is in overbought territory (above 80). It will generate a sell signal when it turns lower from here – which could happen any day.
This setup looks similar to the action in early January – just before the banks started to report earnings.
BKX rallied 15% in December as investors discounted the likelihood of strong earnings reports. Then, as the reports were announced, and they were as strong as expected, BKX declined.
Investors sold on the news. The bank index lost 17% in two months.
A repeat of that sort of action this earnings season could be a bearish omen for the rest of the stock market.
Let’s keep an eye on the BPFINA. If it turns lower from here, we’ll have a new sell signal for the banking sector. And, in turn, we’ll have another reason to be cautious on the broad stock market.
Best regards and good trading,
Jeff Clark
Editor, Market Minute