Futures are down sharply as yesterday’s currency moves and VIX smackdown are being unwound by Moody’s banking downgrades. At least banks aren’t waking up to a 40% windfall profit tax such as Italy just imposed.
This timely bit of truthiness certainly has the potential to get ES to our SMA50 target in the lead up to Thursday’s CPI print. As for XLF, the timing couldn’t be worse.
Fear not, the Fed is already tapping the brakes.
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After being stuck in a textbook triangle pattern for almost six months, XLF finally broke out last week.
We noted its having reached overhead resistance a few weeks ago [see: Yield Curve Model – Correction Imminent.] At the time, the 2s10s was threatening a breakout which, per our model, suggested a downturn for equities in general and XLF in particular.
The 10Y did, in fact, reverse as expected and XLF dutifully tumbled – but, to a higher low. By Oct 30, a triangle was very well established and we were again facing a break out vs break down decision. Note that XLF had dropped through its SMA200 and was in a bearish SMA10/20 alignment. 
Had interest rates continued falling, I have no doubt that the triangle would have broken down and XLF would have reached the .618 Fib at 21.06. Instead, the 10Y popped back above its SMA200 (the yellow arrow)…
…and XLF got a much-needed bounce back to the top of the triangle. Yes, again. This time, however, TPTB were ready. After bumping into the top of the triangle on Nov 5 and 6, XLF received a fabulous gift.
The 10Y gapped sharply higher, again breaking above the SMA200 it had fallen below and even above the top of the rising white channel. It was a massive move from 74.8 bps to 97.5 bps (point 6 in the chart above) in just two sessions thanks to the announcement of a vaccine from Pfizer and better than expected employment data [see: Vaccine!]
As a result, the 2s10s broke above overhead resistance. 
A steeper yield curve is theoretically the solution to the banks’ woes. Though, historically, major breakouts in the 2s10s have led to equity crashes. 
Even for XLF. 
We’ll see if this time is any different.
In the meantime, XLF has backtested the midline of the rising white channel from its 2009 lows…
…following its very obvious failure to break out to new highs in February which resulted in its 44% crash. Note that a failure to push above the midline means at least a backtest of the triangle top around 25.26. Much will depend on some very fancy footwork by the Fed.
The Fed’s exercise in ZIRP, which served as a lifeline to many sectors of the economy – not to mention the stock market, is a weight around the neck of the financial sector.
Rising rates and a steeper yield curve might be okay with $7-8 trillion in debt. But, at $28 trillion, it’s a tad scary.
Can the Fed find a way out of the corner into which they’ve painted themselves? Can they maintain the disconnect between the S&P 500 and the pandemic-stricken real world in which 30% of Americans are expected to be infected and another 200K are expected to die?
“We’ll spend the next three months probably infecting another 15% and get to 30%, maybe more,” [former FDA Commissioner Scott] Gottlieb, now a CNBC contributor, said on “Squawk Box.” “Thirty percent assumes the current run rate if things don’t get any worse.”
Stay tuned.
Our yield curve model is again sounding the alarm on overpriced equities. Unless the 10Y – which closed its June 8 gap this morning – declines sharply right away, the 2s10s spread signals a sharp equity downturn to finish the correction which began on Oct 12.
The bad news for equities? A sharp drop in the 10Y also portends a correction.
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As the cause of the global financial crisis, the financial sector caught the brunt of the melt-down — falling 85% between 2007 and 2009 versus SPX’s mere 57%.
Since bottoming in Mar 2009, it has continued to move in exaggerated fashion relative to sectors receiving lesser freebies from its servants on Capitol Hill and Constitution Avenue. In major rallies, XLF has averaged 1.44X the size of equivalent SPX rallies. Its declines have averaged 1.34X SPX’s.
In important declines, it has led SPX more often than not — putting in a top 4 1/2 months before SPX in 2007 and 2 1/2 months in 2011. In important rallies, it has launched in unison with SPX.
Like SPX, it has ignored some of the normally influential patterns of the past several years. Access to cheap free money has trumped the valuation disasters lurking on balance sheets of companies that are legally exempted from accurate reporting.
So, it’s with some trepidation that I point out a few approaching trip wires.
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XLF spent about 6 weeks dallying around the .382 retracement of its fall from 38.15 to 5.88, finally squirting through in late April.
Like SPX, it peaked on May 22 — only to tumble 8.6% (versus 7.5% for SPX.) The Jun 24 bottom wasn’t particularly motivated by a harmonic pattern or channel; it simply turned with the rest of the market.
Close up, there’s a potential IH&S that targets 21.50 or so that completes around 20.00 — otherwise, no remarkable patterns. The Jul 1 high was a .786 retracement of the May 22 high.
So, odds are we’ll see either a Butterfly Pattern (20.83 or 21.44) or a reversal to test the purple channel bottom (late July, 18.05.)
On April 2, 2012, SPX completed a Butterfly Pattern at 1421 — the 1.272 extension of the July – October 2011 plunge. It provided a great entry point for the fledgling pebblewriter.com’s first major short position.
We scored over 20% in about 2 months [see: All the Pretty Butterflies] trading the 11% decline.
XLF hadn’t done as well up to that point. It had only retraced a Fibonacci 78.6% of its 2011 decline from 17.2 to 10.95. So, no surprise that it sank by a whopping 18%.
In response to a consulting client who was bottom-fishing for financials, I discovered they were probably bottoming in early June. I posted my results in the appropriately titled: So Crazy It Just Might Work. If anything, my estimates were conservative. XLF has soared 41% since that low (turns out it was the day before.)
And, wouldn’t you know it, XLF has gone and formed its own Butterfly Pattern — just like SPX did in Apr 2012.
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Financials have had a great run ever since we called the June 4, 2012 bottom [see: So Crazy, It Just Might Work]. But, all good things must come to an end. I’d give them another few days/points at most.
I had jumped on the short side Mar 27, 2012 [see: End of the Line and Lots More], riding GS, MS and JPM down around 30%.
JPM: 46 – 32 = 31%
GS: 127 – 92 = 28%
MS: 20 – 12.50 = 38%
On June 5, we loaded up on the long side. Our targets, as posted that day:
JPM: today’s close = 31.99, price target = 38.69 (+21%)
C: today’s close = 25.75; price target = 34.79 (+35%)
BAC: today’s close = 7.10; price target = 11.34 (+60%)
Obviously, those targets proved to be a little conservative. JPM reached its target by Aug 21, consolidated for 2 weeks, then zoomed even higher – reaching 49.31 today and finally (after 4 near misses) reaching the .886 retracement of its 53 to 14 plunge.
C reached its 34.79 target on QE3 day (Sep 14 — lovely being able to dump all those crappy MBS on the Fed) backed off a few points, then proceeded to rally up to today’s high of 44.50.
It only ever recovered 7.95% of its 2007-2009 plunge from 570 to 9.70 (adjusted for reverse splits) and is struggling to reach the .786 of its swan dive from Jan to Oct 2011: 51.50 to 21.4. If the .786 at 45.06 doesn’t do the trick, the .886 at 48.07 should.
And, just today BAC came within a nickel of the 50% retracement (12.39) of its post-2009 high. It reached our 11.34 target in mid-December.
If it gets past 12.67, it could still take a run at 14.13. But, it won’t be easy.
Most of the financials are in a similar situation — at or near major resistance either from Harmonic or Chart Pattern targets. But, it’s XLF itself that looks shakiest.
Today, XLF reached an important channel line as it tagged the 1.618 of the Mar-June 2012 decline.
If it sneaks up past current levels, the .382 retracement of the fall from 38.15 in 2007 is waiting at 18.21.
Around the horn with major indices and currencies… Like SPX, most are at a threshold where they must either break down or break out (I think “break down,” but we’ll know soon enough.)
Coming up: VIX, RUT, COMP, NYA, NDX, DJIA, FTSE, SPX, DX, EURUSD, USDJPY, AUDUSD, CL, GC, SI. And, yes, I’m happy to take requests — first come, first served after the above are done.
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VIX
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The last time I devoted an entire post to financials [June 5: So Crazy, it Just Might Work] XLF was down nearly 19% from its March highs. I held my breath and made some ridiculously bullish predictions.
But, all good things must come to an end, and I think the tide is turning for financials. Don’t get me wrong…I still think they’re dead meat in the longer term. I just think we’re looking at a sizable bounce here and now if — and let me be clear, it’s a very important IF — the rumors are true and Kumbaya Banking and Quantitative Whatever are back.
If not, this entire exercise isn’t worth the bytes it’s written with. The financials, along with just about everything else Bloomberg quotes, will roll over and die. OK, with that huge caveat out of the way — and before you laugh me out of cyberspace — here are my targets:
JPM: today’s close = 31.99, price target = 38.69 (+21%)
C: today’s close = 25.75; price target = 34.79 (+35%)
BAC: today’s close = 7.10; price target = 11.34 (+60%)
Turns out that was the low for both JPM and C. JPM reached our target on Sep 6 and tagged on an additional 5 points by October 17. Citi reached its target on Sep 14 (same day SPX peaked) promptly dropped 10%, then rallied another 3.5 points to form a nifty little double-top on October 18.
BAC was my one disappointment. It had achieved a nice 38% return when it peaked at 9.79 on Sep 14, but had fallen short of my price target — a Fibonacci 61.8% retrace of its 68% 2011 plunge. Apparently I had been too optimistic. Or, so I thought…
Don’t look now, but in the past couple of days BAC has shaken off its laggard status and is once again spiking higher — trading within 66 cents of my June forecast. As has been widely reported, call option buying is going through the roof.
Sadly for those speculators, though, it’s going to take lots of unicorns farting rainbows for those calls to pay off very big. Why?
Reason #1: Yep. Two Crab Patterns pointing to the same conclusion — a reversal near current prices.
Reason #2: Uh-huh. Rising wedge, plain as the note on your place.
Reason #3: Bad channel karma everywhere. Maybe those call buyers don’t look at charts much? Yikes!
Reason #4: How about a Fib .382 reversal? It’s not usually the end of the world, but it is a Fib. And, it’s surrounded by a bunch of little channels that are about as cute as a pack of Dilophosaurus.
I’m not going go all negative and start talking about the massive fundamental problems BAC faces — as do most other banks. But if BAC hasn’t done its thing by the time the market does its mama bear crash here over the next few weeks, it’ll be a couple of months before it gets another shot.
If it’s lucky, the sell-off will only be to 9.12. But, it the white channel mid-line doesn’t hold, you could through another point or so on the fire.
What does this mean for the rest of the financials? Think in terms of a downdraft on Monday. XLF needs 8 cents to reach its .786 (or .21 for the .886), which ought to get the party started to the downside.
JPM needs .47-.61 to reach a prime target for reversal — either 43 or 43.14.
And, C has about 44 cents of life left in it; 38.19 oughta do it.
When it comes to significant moves, financials often lead the broader markets. Fortunately for our forecast, they are only one good pop away from being ready for a slide. Having them on board in the next session or two should get us where we want.
As a member correctly pointed out in his comment on XLF Update, a ramp in XLF would mean some big returns for important components such as BAC, C, JPM, etc. This is very true. Though it pains me to say it, I think banks are ready for a bounce.
I sold all my remaining JPM, GS and MS puts today. I jumped on the downside March 27 when JPM was 46 [see: End of the Line], GS was 127, and MS was 20 [see: Lots More Where That Came From.]
I bought puts, but even straight-up short positions would have made some decent returns over the past nine weeks:
JPM: 46 – 32 = 31%
GS: 127 – 92 = 28%
MS: 20 – 12.50 = 38%
But, all good things must come to an end, and I think the tide is turning for financials. Don’t get me wrong…I still think they’re dead meat in the longer term. I just think we’re looking at a sizable bounce here and now if — and let me be clear, it’s a very important IF — the rumors are true and Kumbaya Banking and Quantitative Whatever are back.
If not, this entire exercise isn’t worth the bytes it’s written with. The financials, along with just about everything else Bloomberg quotes, will roll over and die. OK, with that huge caveat out of the way — and before you laugh me out of cyberspace — here’s what I’m looking at.
My targets are as follows…
JPM: today’s close = 31.99, price target = 38.69 (+21%)
C: today’s close = 25.75; price target = 34.79 (+35%)
BAC: today’s close = 7.10; price target = 11.34 (+60%)
JPM:
CITI:
BAC:
My favorite. It starts with this little H&S pattern back in the 2007 market top. Keep an eye on those ascending trend lines.
Here they are again, on the bigger picture, along with some descending ones, and a nice little channel (red) that works pretty well since early 2009. Couple of nice channels on the RSI, too.
This one’s a bit of a long-shot, because it means breaking the red fan/channel coming down from the right shoulder up there, but the RSI channel makes me wonder if we might just make it up to that 61.8/1.618 Fib level. If not, I think 8.89 is a safe bet.
So, there you go. Earlier today, XLF July 15 calls sold for .09 and the August 14’s went for .49. If I’m wrong, they’ll probably go to negative eleventy-hundred. Then again, it’s so crazy it just might work!
Right about here, my attorney would want me to remind you this is not an investment recommendation — nor is anything on pebblewriter.com. Investing is risky, and options are a particularly effective way to end up living in a van down by the river. For full risk advisory and other legal disclosures, read this.
