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Watch Those Banks...

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The KBW Bank Sector Index (BKX.X) - a broad gauge of banking issues - turned lower last week ahead of the S&P 500's (SPX.X) pullback today. The rollover in the BKX.X began last Thursday with the failure to trade above its 10-dma at 784 at that time. Following the rollover, the BKX.X traded lower into the weekend.

Fast forward to this morning, and the BKX.X is once again trading lower, but only marginally lower at the time of this writing. But the BKX.X's weakness this morning comes in spite of a seemingly positive earnings report from Bank of America (NYSE:BAC) -- a component of the BKX.X. Shares of Bank of America gapped higher this morning off of the company's 3 cents per share better-than-expected third-quarter numbers. Yet the stock sharply dropped just a few moments into Monday's session and at the time of this writing was fractionally lower.

Perhaps the selling into strength I witnessed in shares of Bank of America earlier this morning stemmed from continued concerns over credit quality among banking issues. Or possibly on fears of a further slowdown in the economy. Whatever the reason, the BKX.X is approaching a key support level at 750.

The BKX.X has bounced from the 750 level twice in the recent past and is again approaching that level. Of course a print at the 745 level on the point & figure chart below would place the BKX.X on a sell signal by taking out its most recent previous column of Os at the 750 box.

If the BKX.X fails to bounce from the 750 level on this leg lower and goes on to a print at 745, then it could have downside to 740, or possibly as low as 715. But what impact might that scenario have on the broader market???

I give a lot of credence to the BKX.X because, first of all, the financial sector is the largest industry group of the S&P 500. Second, the banking business is an excellent gauge for the health of the broader economy.

So, I think that the BKX.X is an excellent way to get a hold on economic activity and it sometimes can be used to predict the path of the broader market (S&P 500). And here's the action plan:

If the BKX goes on a sell signal WITH A PRINT AT 745.00, then it may portend further weakness in the S&P 500. If that's going to be the case, it may be worth while to look for the weakest sectors of the S&P 500 for some bearish trades.

Or, if the BKX once again holds 750 AND DOESN'T PRINT 745.00 on this leg lower, then traders might wait for the sector to begin lifting from its current levels. In that event, the S&P 500 might start following the lead of the BKX, at which time looking into the strongest sectors of the S&P 500 might be a good practice.

Eric Utley
Option Investor

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