Money center banks traded strongly in 2019, while smaller regional players failed to attract significant buying interest, setting off a major bearish divergence. This conflict could come into play during fourth quarter earnings season, with two potential outcomes. First, weaker banks could play catch-up with the biggest players, carving strong rallies to new highs. Or second, and more likely, investors could take profits in overbought sector giants, triggering intermediate tops.

A stockpicker's market could also emerge, allowing a few sector leaders like Dow component JPMorgan Chase & Co. (JPM) to continue their rapid ascents while the majority eases into less bullish price action. Fortunately, we don't have to wait long to see how this divergence plays out because earnings season starts next week, with reports from JPMorgan Chase, Citigroup Inc. (C), Bank of America Corporation (BAC), and PNC Financial Services Group, Inc. (PNC).

Chart showing the share price performance of the SPDR S&P Bank ETF (KBE)
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The SPDR S&P Bank ETF (KBE) recovered the majority of losses posted during the 2008 economic collapse in three rally waves that reached the .786 Fibonacci sell-off retracement level in January 2018. The fund sold off for the rest of the year, posting a two-year low at $34.93 in December. The 2019 bounce stalled at the .786 retracement of the 2018 decline at year end, with weak price action so far in January 2020.

However, the fund is now trading at 50-day exponential moving average (EMA) support, raising the odds for relatively strong action, at least during the first part of earnings season. Even so, price patterns of big money banks look far more constructive, with top names trading at or above their 2018 peaks. The first sign that smaller-tier banks are ready to play catch-up will come when this instrument clears harmonic resistance just above $48.

Chart showing the share price performance of JPMorgan Chase & Co. (JPM)
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Sector leader JPMorgan Chase & Co. has carved an extreme divergence with the bank fund in recent months, breaking out above 2018 resistance and posting a healthy string of new highs. It started the current ascent after hitting a 14-year low at $15.02 in March 2009, initially stalling in the upper $40s in 2011. A 2013 range breakout gained traction into 2015 when the stock completed a 100% retracement into the 2000 high near $60.

The stock broke out following the 2016 presidential election, finally stalling at $119 in February 2018. A rounded correction into the fourth quarter of 2019 brought skeptical investors off the sidelines, generating a fresh breakout that posted an all-time high at $141.10 on Jan. 2. However, the monthly stochastics oscillator has now reached an overbought level that has triggered four major sell signals since 2012.

Chart showing the share price performance of Citigroup Inc. (C)
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Citigroup Inc. still hasn't broken resistance at the 2018 high, unlike Chase and Bank of America, but that could change after Tuesday's pre-market earnings release. The company nearly went bankrupt during the 2008 bear market and was forced to issue a 1-for-10 reverse stock split in 2011 to improve liquidity. It entered a new uptrend after hitting a split-adjusted $9.70 in 2009 and stalled quickly in the mid-$50s, establishing resistance that took eight years to overcome.

A 2017 breakout added about 25 points before stalling just above $80 in January 2018 and turned sharply lower in a major correction that found support at a two-year low in December. The 2019 bounce unfolded in two rally waves that completed a 100% retracement into the prior high on the first trading day of 2020. It is now hovering around that level in a holding pattern, with even odds for a breakout or reversal following next week's report.

The Bottom Line

Big money center banks have gained more ground in the past year than the vast majority of smaller players, setting off a divergence that reveals hidden sector weakness.

Disclosure: The author held no positions in the aforementioned securities at the time of publication.