E-Trade Financial Corp. (ETFC) — On May 21, we issued a bearish call on this stock based on an emerging head-and-shoulders pattern on its chart, as well as the yield on the 10-year Treasury note dropping below support at 2.6%. But a number of things have changed since then that have caused us to reverse our position.
First, after dropping to near-term lows, bond yields are starting to creep higher, moving above 2.6% on Monday, as investors and economists worry a bit more about inflation. Rising yields cause yield spreads to widen, which is good for financial institutions like stock brokers that make a large portion of their profits from this spread.
While we worry about inflation, the European Central Bank (ECB) is taking steps to combat deflation. The overall market responded positively to its plans for additional monetary stimulus measures, and this rally gave new life to ETFC, which was on the verge of breaking below support. In fact, ETFC broke above its downtrending resistance level and appears ready to start challenging its 52-week highs made in March.
This breakout corresponds with a bullish divergence between the price of ETFC and the Relative Strength Index (RSI). RSI started making higher lows in early April, while ETFC was making lower lows, a classic sign that a pullback in the middle of a longer-term uptrend is drawing to a close.
With the bullish move on Friday and Monday, the head-and-shoulders pattern we were watching was negated as the stock pushed back above the neckline that was broken to complete the pattern. No pattern is infallible, and it’s important to recognize a reversal when it happens.
For these reasons, we are reversing our outlook on ETFC. The stock is likely to resume its longer-term uptrend.
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