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Banking on a Recovery

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If you're betting on an economic recovery, you'd like to see the banks gain some traction. The sector is perhaps the best indicator of the overall health of the economy, and the market for that matter. If nothing else, it should be known that the broader financial group is the largest industry segment of the market. The financials currently account for 19 percent of the S&P 500 (SPX.X) as measured by market cap. The financials far outweigh the next largest industry segment in information technology, which accounts for only 15.3 percent of the SPX.

One of the best gauges of the broader financial group is the KBW Bank Sector Index (BKX.X). It's a basket of large, diversified financial firms, ranging from money centers such as J.P. Morgan Chase (NYSE:JPM) and Citigroup (NYSE:C), to savings and loans such as Washington Mutual (NYSE:WM) and Golden West Financial (NYSE:GDW).

The BKX is under pressure this morning following a profit miss from Citigroup. The mammoth bank reported that it had taken a charge related to its Argentina business, which led to the profit miss. At the time of writing, shares of Citi were lower by 2.50 percent, leading the BKX lower.

What the bulls -- market and economic -- don't want to see is further downside in the financials. But the BKX appears to be heading lower, that is if its short-term support doesn't hold. The BKX stopped at a retracement level last week right around the 875 level. The bracket that I've used is a simple measure of last fall's rally, using the September low and March high as anchor points. Now, a pullback to this level is not all that disconcerting to the bears. Profit taking is only that. But what the bulls don't want is a break below this retracement level, because that would shift risk to the next level near the 830 mark.

BKX - Daily

What's interesting is that the bullish support line from the point and figure chart lines up with the 830 retracement level. These coincidences can often become self fulfilling prophecies. Using the most recent sell signal, the vertical count for the BKX is currently 845.

BKX - Point and Figure

Through this morning, the BKX is testing the 875 retracement level. At this point, the pullback isn't that alarming to the bulls, but further downside could have that sentiment shifted. While there may be a trade in the BKX to the downside, what I'd rather focus on are the ramifications of a breakdown in the financials. Further weakness would reveal more about the state of the economy, and would certainly pressure the broader market (SPX.X) lower.

Eric Utley
Option Investor

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