$BKX - Banks - Topping or popping?

The significance of the banking sector in the stock market cannot be understated for several reasons. First, the banking sector offers important clues regarding the overall health of the economy. Secondly, a strong banking sector is one of the cornerstones of a robust capital market. Finally, the financial services sector is a significant portion of the U.S. equity market due to its weighting within the S&P 500, 16%. Making it the second-largest within the S&P 500 behind technology. For these reasons I watch the movement of the banking index for stock market directional hints but most importantly as a health scorecard of the overall stock market.  If bank stocks are rising and strongly bullish, the broad market should follow.  The opposite, as you would expect, holds true too.

The chart below is that of the bank index. After making post 2009 highs in March, the index had a minor correction in May falling 9% down to 66.91.  Since then I have been watching closely to see if new highs were going to be made. If not, that would raise a cautionary flag because if we print a lower high, this COULD be the start of a downside reversal. Three other reasons for concern are 1) as of today price broke down out of the bear flag which I have highlighted in brown; 2) if early July’s high holds, we have potentially formed an inverse head and shoulders (IH&S) reversal pattern and 3) we have negative divergence on both oscillators which tells us upside momentum is waning.

In the natural ebb and flow of the stock market, prices rise and fall and after the May-July rally I would expect the banking index to come under some weakness whereby price could understandably fall back to the blue support rail.  If downside momentum persists and support does not hold, the next logical target would be ~61, (the target for the IH&S pattern). Interestingly, this level coincides exactly with the prior low printed last October.

Of course, all of these warning flags get negated if the bulls can pop prices higher, closing above 72.91 thereby making new highs. Either way it goes, I expect this summer-fall season will be more exciting than the past 2 years and may present us with some wonderful investment opportunities, including maybe even the banking sector.