Bears did win a few battles last week, but the bulls are still in charge. That is the case with bank stocks. They’ve been on sale last few sessions, but that comes from a very high levels. In theory, investors should be looking to catch the falling knives in the sector. In reality, they also have to account for the market as a whole.
Buying them now could be too soon, so patience is a virtue.
Friday felt like extreme pain, but at the scoreboard the S&P 500 was barely down 0.8%. Buy the dip has been a winning strategy thanks to the Federal Reserve’s safety net. Staying in that mode too long is how bull traps develop. The behavior will suddenly change and late-comers then find themselves owning upside down equity position.
Bank stocks have been more active this year than in a long while. They have buried the reputation that they can’t hold a rally once and for all. In February, they broke out in a big way, some as much as 30%. The exuberance went too far because of the meme that took it there. Investors were chasing bank stocks on the back of runaway Treasury yields. Those have since stumbled causing a stall because they lost their tailwinds. Now bank stocks have to find support from a precarious perch.
Bank Stocks More Attractive From Lower Levels
My disclosure today is that I successfully shorted them on the way up. I picked on a few high profile names like Goldman Sachs (NYSE:GS) and won. Now as they fall into support I would start looking for bullish opportunities. They are all cheap, which is an undeniable fact. That alone will not create support so soon. What drives stock prices often are the expectations that lay ahead.
The group reported earnings last week and they crushed it. They are now fortresses with too much cash on their hands. That’s why the reverse repo window is busier than ever. This doesn’t always translate into higher stock price.
Great report cards are not reason enough to buy bank stocks now. However, falling into support zones is what will eventually make them interesting. Morgan Stanley (NYSE:MS) is not one of them because it’s still hanging on close too close to its all-time highs.
It’s also important to track bond yields. They are lingering dangerously above a potentially bearish trigger. If they stumble, it would indicate that there’s more downside in banks. Remember we noted that this was the reason bank stocks rallied. Now it could become a cause for pain if yields fall further. Nevertheless, the long term opportunity is real, and today we look into three worthy of catching – eventually. They are:
Bank Stocks to Buy: JPMorgan (JPM)
We will start with the bank that Wall Street deems as the king of them. JPM stock represents the best of the best. It had a bad day on Friday – down 2.3%, but it held above the low from July 8. It recently set a new record for itself, and now it’s barely 10% below that. This by no means is a disaster unless the selling persists.
The danger for the bulls from here is if JPM stock loses its next to support zones. Below $147 per share, the bears could target another 10% drop from there. That’s not my forecast but it’s definitely a scenario that is just around the corner. Conversely, I expect sellers on pops into $160 per share.
I like the levels but I don’t like the opportunity. The financial metrics are strong but so was the price action. My concern is with the expectations that Wall Street has already built into its price. Patient investors who wait out the next couple of weeks may have a better opportunity to buy the stock lower. This notion is true for the next two banks stocks today. The downside risk far out weighs the upside opportunity.
I hate losing more than missing out, so I have no qualms about waiting and being patient. The rally in the bunch was unusual, therefore, I should expect the unusual to continue to happen. These are new circumstances for us to navigate and we should do so cautiously. I could use options to sell puts instead of buying shares. This would leave a big room for error.
Bank of America (BAC)
Bank of America stock is slightly worse off then JP Morgan. I say this in relation to its most recent support zones. BAC stock closed on Friday at its current support. Meaning it doesn’t have much short-term help for the bulls. The slightest red day this week could bring about more selling.
The better opportunity is to wait for a dip into $35 per share before re-engaging long. I am not short the stock anymore, and I wouldn’t do so now. Any relief pops in BAC stock this week will face selling into $40 per share. Just like I wouldn’t chase it on the way up, I don’t anticipate a bottom on the way down.
Investors should let the price action tell them that it hit rock bottom. This happens when there would be no more lower-lows and at least one double bottom. There’s no such evidence yet and patience will prevail. The fundamentals here as we’ve noted like for all bank stocks are solid. This company is on rails so it won’t collapse. I suspect there will be better entry opportunities later this year.
Bank Stocks to Buy: Financial Select Sector SPDR Fund (XLF)
Instead of trading individual bank stocks, investors can cast a net on the whole sector. The XLF stock is a liquid ticker that can do the job in one swoop. Just like the individual components of it, the XLF is slightly off its all-time highs and has support. This morning that is under fire and it better hold. Else there is another trigger for more pain this week.
Like the situations for JPM than BAC, there is hope below that the bulls can find footing. There were strong bounces on July 8 and June 18 candles. However, if they fail to find support going into that $35 per share, I expect more pain ahead. The technical pattern would invite more sellers and then target a $3 drop from there.
Conversely, there are sellers lurking at $37 per share this coming week. This is important because the important bit is watching what happens on the pops. The behavior is key to understanding the trend. Investors want to avoid chasing a bottom as it starts developing a new descending trend. That’s how we get trapped upside down in stocks for months. Machines control the action and they will sell the pops. We humans need to heed their code and act accordingly.
The rally that took bank stocks to their highs was too strong. Therefore, getting a painful correction would be normal. They say extremes are wrong and somewhere in the middle lies the truth. In this case, this would be closer to $32 per share. Even if that happens, technically the bulls will still be in charge of the weekly stock price action.
On the date of publication, Nicolas Chahine did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Nicolas Chahine is the managing director of SellSpreads.com.
