U.S. commercial banks kick off second quarter earnings season next week, after a tough first half in which the majority of components ran in place while the S&P 500 lifted to another all-time high. Trade wars and the Fed are to blame for this losing streak, with the prospect of lower rates and an economic slowdown weighing on bank shares. Unfortunately for bulls, these headwinds are likely to continue in the third quarter, lowering the odds for sustainable upside.

Banks love Fed tightening, at least in the early stages, because it increases the spread between rates that banks pay for short-term capital and the rates paid by their customers. The group led the market higher in 2016 and 2017, with the Trump presidency and tax cuts expected to super-charge capital spending. The rest is history, with companies pocketing the tax windfall or buying back stock instead of pumping money into economic growth.

Trade wars have taken an equal toll, denying U.S. corporations international opportunities while putting a lid on the 10-year expansion. It's no coincidence that the sector topped out in the first quarter of 2018, at the same time that Trump first threatened China, Mexico, and other trading partners with levies on imported goods. Many of these duties have been in place for months now, adding to systematic strains that could trigger the next recession.

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) sold off in a cascading decline after topping out above $60 in 2007, coming to rest in the single digits in 2009. It bounced off that historic low in three broad waves, topping out nearly 10 points under the prior decade's peak in March 2018. The fund carved a descending triangle with support in the upper $40s and broke down in October, dumping to a two-year low in December.

The bounce into 2019 stalled at new resistance in February, yielding broad sideways action that has taken the shape of an ascending triangle with support near $40, while failed rallies above the declining 200-day exponential moving average (EMA) have carved triangle resistance centered near $46. The fund is trading about two points below that barrier this week, setting up a potential breakout during the upcoming earnings season.

However, the first pullback to the new resistance level marks a traditional short sale opportunity because breakdowns tend to trap a large supply of shareholders who are looking to get out even when a bounce approaches their purchase price. Given this bearish set-up, it makes sense to keep a sharp eye on triangle support at $40 because a breakdown would open the door to a test at the 2018 low.

JPM
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JPMorgan Chase & Co. (JPM) shares completed a round trip into the 2000 high at $67.20 in 2014 and eased into a sideways pattern, ahead of a historic breakout following the presidential election. The stock doubled in price between the third quarter of 2016 and the first quarter of 2018, posting an all-time high at $119.33, ahead of a double top breakdown and decline that reached a 15-month low in December.

The 2019 rally remounted broken support in April and stalled within three points of resistance a few weeks later. It spent the rest of the second quarter grinding lower, held back by the breakdown in U.S.-China trade talks. The stock has bounced modestly in reaction to renewed talks and could test last year's high if the company beats estimates on July 16. Even so, it's unwise to expect a sustained breakout because underlying metrics are weaker than price action.

The on-balance volume (OBV) accumulation-distribution indicator posted an all-time high in February 2018 and entered a persistent distribution wave that reached a two-year low at year end. OBV barely budged in the first half of 2019 while the stock rallied nearly 15 points, setting off a major bearish divergence, warning that this instrument lacks the institutional and retail sponsorship needed to hold higher prices.

The Bottom Line

Commercial banks could rally after second quarter earnings, but the sector may continue to lag broad benchmarks well into the next decade.

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