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Summary

  • Bank of America popped nearly two percent Monday on no news.
  • I posit the rally is unjustified and will prove to be a dead cat bounce.
  • This risk/reward equation to buy prior to earnings is now unfavorable.

I am bullish long-term on Bank of America (NYSE:BAC), yet will wait until after earnings to start a position in the stock. The risk/reward equation just got slightly less favorable with Monday's pop in the stock. In the following sections, I will lay out my case to wait until after earnings prior to starting a position.

Bank of America popped nearly two percent Monday on no news

The market seems conflicted these days. One day it's up, and the next it's down. Bank of America popped nearly 2% on Monday, with no major news being reported on the stock. With earnings coming up on Wednesday, the rally in the stock seems suspect.

(click to enlarge)

(Chart provided by CNBC.com)

I posit the rally may simply be a dead cat bounce. A dead cat bounce is a small, brief recovery in the price of a declining stock. The axiom is derived from the idea that "even a dead cat will bounce if it falls from a great height."

Rally is related to Citigroup earnings beat and a strong March retail sales report

Stocks rallied Monday, with the S&P 500 rebounding from its worst week since 2012. Earlier Monday, it was reported March retail sales jumped the most since 2012, and Citigroup posted earnings that beat estimates.

I posit Bank of America's stock is up for the most part on the news Citigroup (NYSE:C) bested earnings estimates and is up nearly 4% today. Many investors lump Bank of America and Citigroup into the same basket. The issue is, this could not be further from the truth. Bank of America's stock is up nearly 30% over the past year, while Citigroup's stock is up merely 2%. Bank of America's stock is currently trading 43% above the 52-week low, while Citigroup's stock is only 8% off the 52-week low. A counterintuitive view may be that the beat by Citigroup could be bad news for Bank of America. Market participants may rotate out of Bank of America into Citigroup. The case can made Citigroup actually has more upside potential at this juncture - yet, that is another story.

The risk/reward equation to buy prior to earnings is now unfavorable

With Bank of America reporting earnings on Wednesday, I believe the risk/reward equation for starting a position prior to earnings is now unfavorable. An earnings beat by Bank of America seems telegraphed at this point. The problem is this may lead to another buy the rumor, sell the news situation occurring, even if the bank beats earnings. This is essentially a lose/lose scenario for investors looking to get long the stock prior to earnings. There is no support under current levels. A 7% drop in the stock may occur in a worst-case scenario.

(click to enlarge)

(Chart provided by Finviz.com)

Further, the drumbeat of bullish comments from analysts on Bank of America seems to have picked up substantially in recent days, as evidenced by a plethora of bullish articles recently published. This may indicate any good news may be fully priced in at current levels.

Conclusion

Look, if you are interested in making a long-term investment in Bank of America's stock, I would wait until after earnings to start a position. Buying a stock the day before earnings is too much of a gamble. Waiting until after earnings flips the situation to a win/win scenario for potential investors. First, the company may confirm your bullish thesis and vastly reduce the risk in starting a position. Second, the company sells off on a miss due to a transitory issue, giving you a better entry point. Regardless, most initial pops after an earnings beat tend to fade in a few days prior to moving higher, as evidenced by the chart below

(Chart provided by Scottrade.com)

So, even if Bank of America beats earnings estimates and rallies higher on the news, I am sure you will get another shot at a decent entry point in the near future. The market currently has no idea which way it wants to go. In times such as these, it is best to proceed with increased caution. Wait until after earnings prior to starting a position.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in BAC over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Bank Of America: Don't Be Fooled By Dead Cat Bounce