Banks Stocks Are Correcting. Here's Where They Go Next

During my weekly chart review, I noticed a number of sector and industry ETFs that had broken down through key support levels. The SPDR Financial Select Sector Fund ETF (XLF) is perhaps the best example of how these charts have rotated from steady uptrends to more corrective patterns.

The XLF, some of whose top holdings include Wells Fargo & Co. (WFC), JPMorgan Chase & Co. (JPM), Bank of America Corp. (BAC), and Goldman Sachs Group Inc. (GS), peaked around $25.10 in March 2017, then sold off to find support around $23.00 through June. The financial sector then traded back up to resistance (green line in the chart below) before finally breaking out in late July. After what appeared to be the beginning of new leadership for banking stocks, the sector quickly reversed back to the $24.60 to $25.30 range.

In the last week, the XLF has broken down through its 50-day moving average as well as short-term support around $24.60 (purple line). Meanwhile the Moving Average Convergence Divergence (MACD​) indicator showed a bearish divergence with price over the last two months, suggesting a weakening in momentum as the ETF moved to new highs. These shifts, combined with last week’s lower high, suggest a correction is in effect.

Key Levels to Watch

How does a correction like this become more serious? As long as the XLF remains above more long-term support levels, the overall uptrend remains intact. Looking below the current price, the 200-day moving average looks to be lining up with the low from early June, when it was around $23.80. Further down, we have the 2017 lows around $23.00 which have served as support a number of times already.

What would signal an “all-clear” and resumption of the uptrend? For a start, we would need to break above the trend line using the recent highs (orange line). Then we would need to see a convincing break above the recent highs along with the Dow Theory confirmation of higher low prices.

From a macro perspective, similar ETF breakdowns in Health Care (XLV) as well as more established corrections in mid-caps (MDY) and small caps (IWM) suggest near-term caution for equities.

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