After a rough 2011, Bank of America (BAC) is poised to move higher in 2012. There are three reasons for this. These three reasons are important because they have caused me to reevaluate my December conclusion on Bank of America. The first reason is that Bank of America's fourth quarter earnings indicated the firm has reached a bottom. Also, the firm has announced several changes that will cut costs and streamline operations. The final reason - which consists of a detailed technical analysis - is the stock is currently in the process of closing a bullish inverse head and shoulders pattern.
Bank of America's fourth quarter earnings were important because the firm needed to illustrate the future is bright. Fortunately, the company came through and delivered good, not great, results. While annual revenue, net of interest expense, declined year over year, the firm provided positive net income year over year. This is important because it indicates Bank of America is on the right path to success. And in order for the share price to move higher, the firm needs to report impressive earnings.
More specifically, Bank of America reported net income increased from a loss of $1.244 billion to a gain of $1.991 billion year over year in the fourth quarter. Also, net income increased from a loss of $7.299 billion to a gain of $6.232 billion year over year in the third quarter. The first two quarters of 2011, however, did not lead to year over year increases in net income. Therefore, Bank of America began a turnaround on the financial sheets beginning in the second half of 2011 which means the depressed share price will soon head substantially higher as investors and traders become more confident in the equity.
One of Bank of America's weaker points on the financial sheets is expenses. This directly leads to the second reason Bank of America's share price will head higher in 2012. Bank of America's CEO, Brian Moynihan, has addressed this issue over the past few months. The first step of Project New BAC was to eliminate roughly 30,000 positions throughout the firm. This is expected to save the company roughly $5 billion. The next step appears to be cutting less than $5 billion from the investment banking and wealth management unit. It is likely that bonuses or compensation will be decreased as part of the second phase.
We will not know the details until the first quarter of 2012 conference call, but what can be said is that if Bank of America lowers overall expenses the firm will produce higher net income. Higher net income will allow Bank of America to contemplate future acquisitions or dividends for shareholders. Nevertheless, as Bank of America continues to streamline operations investors and traders will send the share price higher throughout 2012.
Let's end with the head and shoulders pattern which is a technical analysis of the firm's stock. An inverse head and shoulders pattern is essentially a reversal of a long downward trend. Therefore, the share price is set to move substantially higher in the medium term. This gives traders and medium term investors an opportunity to capitalize on positive gains from Bank of America.
I will discuss the implications of the inverse head and shoulders pattern later, but for now I will go into great detail in order illustrate the pattern and how Bank of America's stock is within the parameters of the trend.
The inverse head and shoulders pattern begins with a long downward trend in Bank of America's stock. This began during the first quarter of 2011. As you can see, Bank of America's share price successfully met lower highs and lower lows until the August 2011 equities mini crash. This is important because the slope of this trend line must be less steep than the trend line during the initial left shoulder of the pattern being discussed.
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After the early August crash, Bank of America began to create the left shoulder of the inverse head and shoulders pattern. As you can see below, the magnitude of the slope of the left shoulder is greater than the magnitude of the prior long term trend. And, as mentioned above, this is one of the parameters a chart must fulfill.
More importantly, however, as Bank of America's stock headed lower the volume increased compared to the average volume prior to the head and shoulders pattern. This indicates traders were willing to buy the stock on the way down, and/or sell the stock during the temporary weakness. This is important because this volume trend is another characteristic of the inverse head and shoulders pattern.
Bank of America's stock then finished the left shoulder by reversing course and heading back to, roughly, the initial level of the left shoulder which will form the neckline later in the pattern. This is indicative of the closing out of the left shoulder of a head and shoulders pattern. Another critical parameter the stock must fulfill is the temporary upward trend must be on lower volume which indicates investors are not willing to buy the asset as the price increases. It may be difficult to discern, but Bank of America's chart satisfies this requirement, thus completing the left shoulder of the pattern.
The next step for this is pattern is the head. The head is created by a further decrease in the share price which forms a "head" shape. It is important to note, however, that Bank of America's stock has two lows. This does not negate the inverse head and shoulders pattern because it is plausible for this pattern to form in that manner so long as the lowest point is the second dip. Nonetheless, Bank of America's stock forms the first half of the head on lower volume than the left shoulder. It is important to note lower volume is another parameter that must be met for the pattern to be valid. And as you can see, average volume does not necessarily decrease, however what does decrease is the amount of volume spikes.
Furthermore, prior to the head, Bank of America's volume had various spikes. And as the share price was heading down after the left shoulder was complete, the volume spikes decreased in magnitude and number of total spikes. Therefore, the overall volume decreased as the head was forming. This completes the first half of the head.
After the ultimate bottom is reached, Bank of America's share price reversed course and headed back to the same level as the left shoulder which forms the neckline mentioned above. As you can see, Bank of America's share price is currently very close to the neckline which doubles as a resistance point. Therefore, the head will soon be complete and the right shoulder will form shortly.
As you can see, Bank of America's share price is currently two thirds into the inverse head and shoulders pattern. Many traders and investors may come to Bank of America's side and state the share price will continue to move higher because the stock was oversold in late 2011. Also, technical traders will state the stock recently saw the "golden cross" which indicates a bullish future. With that said, the truth is the inverse head and shoulders pattern agrees with these two statements in the medium term.
Since the inverse head and shoulders pattern precedes a medium to long term bull run, traders and investors should welcome this pattern with arms wide open. Another indicator that substantiates the possibility of a temporary reversal of the current uptrend is the relative strength index (RSI). Currently, Bank of America's RSI sits at the highest point since January 2011. Therefore, a downward "healthy" correction is imminent.
Thus, according to the neckline and the RSI, Bank of America's share price will be reversing within the next few days; if not already. The reversal may have began Monday because the share price touched the 7.37 level which is right along the neckline. When this move does begin, traders and investors will see the share price sink to at least the 6.00 range which happens to be a resistance point that needs to be retested before a sustainable long term uptrend can occur.
The final important note to make is Bank of America's medium term price target. Since the inverse head and shoulders pattern is a strong bullish indicator, we can calculate Bank of America's price target based upon the head and the neckline. By adding the difference between the neckline and head to the neckline, we find a price target of 9.88. However, since traders and investors prefer even numbers, Bank of America's medium term price target is 10.00 which is a 38% increase from Monday's close. And when you combine the technical analysis with the fundamental analysis, it paints a pretty picture that Bank of America's share price will head substantially higher in 2012.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.