When there’s a high expectation for a stock like Apple to perform, and the company beats earnings, we have seen investors fade the stock soon after the earnings release. Such was also the case for Qualcomm. But what takes place when the expectations are low in the first place and a company beats those expectations? Like Morgan Stanley today, there is some nice upside potential. This seems to be the theme this week for the financials as expectations and negative sentiment set the stage for surprises and short-covering.
So what happens when 14.6% of an index you’re trying to beat starts to outperform and you have little to no exposure as a mutual fund manager? First off, smart hedge fund short sellers cover and lock in profits at the same time weak-hand investors throw in the towel creating what we call capitulation selling. Look at any bank financial chart and you will see this took place at the end of June as depicted by a spike in volume. Then the same smart money that was short the group goes long, because obviously, if it’s not a good idea to sell something, it might be a good idea to buy it. With little exposure to financials, and concerns around European sovereign crises appearing to fade, fund managers are short-covering and going long financials. European banks are screaming higher today.
Technical Situation for the Banks
The banks have been unloved for sometime in 2011. Looking at a relative strength performance chart of the various S&P 500 sectors, one quickly notices it is at the bottom of the heap. Some of the macro themes that have driven the group down have been slowing economic growth, sovereign debt issues in Europe, and a continual delay in housing’s recovery. What truly is a bank’s book value? Are assets correctly valued and foreclosure risk understood viewing their multiple billions in balance sheet data? It’s a bit too shady and immeasurable for my background.
Before the bank stocks bottomed in late June, momentum indicators had been diverging from price as depicted in a rising RSI versus falling price. This positive divergence took time to setup until finally we got a capitulation in selling late June depicted by a spike in volume. Banks rallied with the stock market from June 27 to July 7th and sold off with the stock market from 7/8 to 7/17. The lows in June have been tested and they’ve held. We now have a double bottom setup in bank and broker stocks.
I’m going to show now some charts on the financial stocks to show why things may be turning around for the group. Many have rallied from their lows this week and some have even broken out like U.S. Bankcorp (USB) did today. U.S. Bankcorp posted earnings yesterday with a .2B quarterly profit. USB is now trading both above the July 1st high as well as above both its 200 and 50-day moving averages. Things are looking up for USB. Volume over the last three days is supportive of the thrust.
The Big Banks
KeyCorp (KEY) and Fifth Third Bank (FITB) have also posted an increase in profits and earnings this week, but let’s look at charts of some of the top banks. That list is JP Morgan (JPM), Bank of America (BAC), Citigroup (C), Wells Fargo (WFC), and U.S. Bankcorp of which we’ve already discussed.
Beyond the top banks, brokers have also had a good week and show the same patterns as the banks. The scrutiny of Congress has helped propel these stocks to ultra low value levels. Notice the rising MACD and RSI through May and June all the while prices headed lower? These were major bullish divergences in momentum that typically forebode major upside moves.
So as summarized from earlier, we can see positive divergence warned of the potential for a reversal. The stocks were oversold near a major demand zone (support) that had supported prices at least two times in the last two years. Prices have rallied to break the downtrend in early July and have recently retested the lows as of Monday, successfully I might add. With positive earnings announcements due to low expectations, stock prices have rallied to test resistance or potentially break out of their basing pattern like USB has. Today, the financial sector is a top performer with the S&P Select financial SPDR Fund up 2.67% while the S&P 500 was up 1.35%. Bank stocks have found a bid, and that was something the bulls have been waiting for since the second quarter to help propel the S&P 500 to new highs. This might just be short covering, but short covering can turn into short-term bullish trends. Sometimes those short-term bullish trends can turn into long-term established trends, especially when bases break out or double bottoms are completed.
