U.S. bank indices and funds fell to four-month lows last week, battered by worries about a slowing economic recovery and a blockbuster report alleging that banks worldwide have been engaged in illegal money laundering for at least two decades. Rising volatility ahead of the presidential election is adding to this bearish brew, inducing many shareholders to close out sector positions and head back to the sidelines.

Key Takeaways

  • JPMorgan Chase & Co. (JPM) and other U.S. banks have been implicated in a massive money laundering scandal.
  • The banking sector has entered a secular downtrend.
  • The September decline has undercut the July low, signaling a bearish waterfall pattern.
  • The top bank fund could test the March low in coming months.

JPMorgan Chase is named in the damaging report, alleging the Dow component has conducted more than $500 billion in suspicious transactions in the past 20 years. The potential involvement of JPMorgan Chase should make a sector-wide recovery more difficult because it's the highest-capitalized U.S. bank, and it could be months or years before government inquiries and legal disclosures run their course.

Sadly for bank bulls, long-term ultra-low interest rates recently forecast by Federal Reserve Chairman Jerome Powell will also weigh on the sector, with the central bank's dovish new formula likely to depress industry profits in the next two or three years. Of course, rates have been declining at a steady pace in recent years, making commercial banks and other lenders among the worst performers of the 11-year bull market.

Even so, bank funds have now hit weekly oversold technical readings, raising the odds for four- to six-week bounces that could offer low-risk entry points for aggressive short sellers. As a result, it probably isn't the best time to press current sales or to give up on long positions and step to the sidelines. However, unforeseen events heading into the election could alter the equation once again, further darkening the outlook for the U.S. economy heading into 2021.

Money laundering is the illegal process of making large amounts of money generated by a criminal activity, such as drug trafficking or terrorist funding, appear to have come from a legitimate source. The money from the criminal activity is considered dirty, and the process "launders" it to make it look clean.

Banking Sector Technical Outlook

KBE
TradingView.Com

The SPDR S&P Bank ETF (KBE) posted a 10-year high at $52.00 in March 2018 and entered a secular downtrend that initially found support in the mid-$30s at year end. A modest recovery wave posted a lower high just below $48 in December 2019, giving way to a pullback, followed by a vertical decline during the first quarter's pandemic outbreak. The fund failed the 2016 breakout during that plunge before bouncing at a seven-year low in the low $20s.

The uptick into June ended at new resistance marked by the failed breakout and 2018 low, yielding a July decline into the upper $20s, followed by a lower August high. This month's selloff has now violated that low, confirming a breakdown through a trendline of rising lows since March. This signals an extremely bearish waterfall pattern that now shows major resistance at the underside of the trendline, broken 50-week exponential moving average (EMA), and failed breakout level in the mid-$30s.

A multi-week recovery wave into that formidable barrier may align with a weekly stochastic buy cycle that hits the overbought level at the same time, offering a potential short sale entry, ahead of the next leg of the waterfall decline. That selling wave has the potential to reach the April and May low in the mid-$20s or continue into a critical test of the March low, completing a multi-year head and shoulders topping pattern.

A head and shoulders pattern is a chart formation that appears as a baseline with three peaks – the outside two are close in height, and the middle is highest. In technical analysis, a head and shoulders pattern describes a specific chart formation that predicts a bullish-to-bearish trend reversal. The head and shoulders pattern is believed to be one of the most reliable trend reversal patterns.

The Bottom Line

The most liquid bank sector fund has confirmed a secular downtrend after failing to remount the broken December 2018 low, raising the odds that it will eventually test March's multi-year low in the low $20s.

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