(Note: The author of this fundamental analysis is a financial writer and portfolio manager.)
Bank stocks have had a brutal first half of 2018, and the current technical charts suggest the second half will not be much better. The KBW Nasdaq Bank Index (BKX) is down nearly 11% from its intraday highs at the end of January, and based on the technical chart may be poised to fall by roughly 8% more, handing the index a decline of nearly 17% from its highs. Many of the big bank stocks have an eerily similar bearish outlook, such as JPMorgan Chase & Co. (JPM ), Bank of America Corp. (BAC ) and Citigroup Inc. (C). (See also: Citigroup's Stock May Plunge 8% Further.)
Options traders are betting shares of the banks fall over 7% as well in their betting in another proxy for the group: the Financial Select Sector SPDR ETF (XLF). The technical and options market analysis runs counter to some forecasts that banks will rise on larger dividends and buybacks. (See also: Why Bank Stocks May Be Ready to Rebound.)
The BKX index technical chart suggests a drop from its current level from 105.30 to 97 in the coming weeks. The first bearish sign is that index has fallen below a more than two-year-old uptrend, which started in February 2016. The second bearish indication is that the index is sitting on a critical support level around 104.50. Should technical support fail, the next level of technical support comes around 97.10, a drop of nearly 8% from its current level of 105.20.
The relative strength index (RSI) has also been trending lower since the middle of January. The chart also shows that the RSI, during a previous period of consolidation from November 2016 to September 2017, hit oversold levels of 30 or lower on three occasions. The more recent period of consolidation has seen the RSI hit 30 only once, and it would suggest that momentum has not finished coming out of the bank index yet.
Options traders are increasingly betting the sector will fall as well, with increasing levels of open interest at the $25 and $26 puts for expiration on Aug. 17. Open interest for the $26 puts has risen to roughly 35,000 open contracts, while the $25 puts contracts have increased to 93,000 open contracts since the start of May. The $25 puts options cost $0.20 per contract, and a buyer of the puts would need the price of the ETF to drop to $24.80 to break even if held until expiration. It would equal a decline of about 7.5% from the ETF’s current price around $26.80.
The banks surged over the past year on the expectations for rising earnings growth in 2018, but those growth rates are expected to slow dramatically at many of the largest banks in 2019. For example, Bank of America's earnings growth in 2018 is forecast to slow from over 39% to roughly 14% in 2019, while Morgan Stanley (MS) is expected to slow from about 31% growth in 2018 to about 8% in 2019.
It would seem the bearish bets and weak technical charts are both pointing to a financial sector that will fade further in the second half of 2018. The only thing left to stop the slide are quarterly results that should start rolling out in the middle of July.
Michael Kramer is the founder of Mott Capital Management LLC, a registered investment adviser, and the manager of the company's actively managed, long-only Thematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of three to five years. Click here for Kramer's bio and his portfolio's holdings. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future performance.