Bank stocks are getting hammered in the wake of recent D.C. disclosures, with shareholders and Wall Street analysts realizing that odds for tax cuts and other business-friendly policies have dropped precipitously in the last 48 hours. The decline follows two months of weak financial sector action, triggered by a near-endless series of Oval Office missteps and self-inflicted wounds.

It was assumed that new legislation would underpin an already healthy U.S. economy while delivering billions of new dollars into the pockets of large corporations. This tax cut mantra has hypnotized the stock market for months, generating a low volume uptick that’s flashed a series of warning signs due to narrow participation and extremely overbought technical readings.  

Banks have waved the biggest red flags in the developing crisis, breaking out to new highs in March and selling off in dead action that failed to respond to upbeat first-quarter earnings reports. At the same time, a weaker-than-expected first quarter GDP has forced the Federal Reserve to slow down its rate hike schedule, denying banks more profitable spreads in their commercial loans.

KBE

SPDR S&P Bank ETF (KBE) sold off from $60.41 to $8.90 in last decade’s economic collapse and turned higher in a stair-step uptrend that paused in 2010, 2014 and 2015. A 2-year low in the first quarter of 2016 attracted strong buying interest, generating a recovery wave that stalled 3-points under the 2015 high ahead of the November election. The results triggered a vertical breakout that also mounted the .618 Fibonacci bear market retracement level at $41. The uptrend peaked at $46.99 on March 2nd, right after President Trump’s well-received address to Congress.

The fund fell more than 3% on Wednesday morning in reaction to the growing D.C. crisis and is testing the lows posted in March and April. More importantly, this price action marks the next stage in a 2-month test at the 50-day EMA, which broke on March 21st. The 200-day EMA at $40 should offer a magnetic target in coming days, with a breakdown at that long-term support level opening the door to a decline that tests the 2016 breakout (red line).

Sector bulls hold a major advantage in this pullback scenario due to strong accumulation, as evidenced by the On Balance Volume indicator (OBV) lifting to the highest high of the decade. Even so, the broad market may be entering unknown territory because the resolution of current political issues could take months or longer, undermining positive sentiment that generated last year’s breakout.

KRE

SPDR S&P Regional Banking ETF (KRE) sold off from $51.12 to $14.42 during the bear market and has outperformed the commercial banking fund since that time. The recovery rally paused in 2014, giving way to a volatile correction that found support two years later in the low-30s. It broke out after the November election, with the buying impulse lifting above the 2007 peak to an all-time high. The uptrend also topped out in early March, ahead of a mid-month breakdown through support at the 50-day EMA.

The fund has been testing the moving average since that time, with this week’s ugly decline likely to confirm new resistance. At the same time, it’s testing new support at the 2007 high (blue line), which needs to hold to avoid a large scale failed breakout that signals a possible bull market top. It’s instructive to note this more locally focused instrument has carved a weaker volume pattern than KBE and could lead the financial sector lower in coming weeks.

The Bottom Line

Banks are selling off aggressively in reaction to rising odds for a constitutional crisis that translates into lower odds for market-pleasing tax cuts. While unpredictable events will dictate final outcomes, deteriorating technicals signal the need for a defensive posture, higher cash levels and taking at least partial profits after the infamous Trump bump.

<Disclosure: the author held no positions in aforementioned stocks or funds at the time of publication.>

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