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Lagging Regional Banks At Top of Range

|Includes:FITB, IAI, KRE, PNC, RKH, SPDR S&P 500 Trust ETF (SPY), STI, XLF
For weeks now the market has been stuck in a range, the S&P500 has has not closed outside 1,080 or 1,110 since the beginning of November - breaking these key levels on the daily charts will be crucial in determining the next break-out or break-down. In my view, financials underwrite any market, they determine the health of the overall market and as of late they have underperformed substantially. Weakness in the dollar has led to commodity/energy based stocks leading this market, however, long-term direction is heavily dependent on the financial sector. My associate Moby Waller pointed out in last week's TraderTalk his concern on this same issue--that was shortly before the Dubai debacle was revealed, which may have been the drag on financials all-along. In this week's SectorSpotlight I want to focus on the Regional Banks, a sub-sector of all financials, which are seem to be the source of financial's weakness. 

Take a look at the performance of all financials through SPDR Financial Sector (NYSEARCA:XLF) compared to the S&P500 Index (SPX), Broker-Dealer (NYSEARCA:IAI) - it's not good. Broker Dealers are outperforming overall financials, however, take a look at the extreme laggard, SPDR KBW Regional Bank (NYSEARCA:KRE) in yellow, the last year it has failed to show any gains and since the March bottom KRE is up 45% compared to the XLF, which is up 144% since the March low.

S&P500 Index (Blue) vs. XLF (Green), IAI (Magenta), KRE (Yellow) - 1 YEAR 

Trading Regional Banks 
There are a few ways that I recommend trading Regional Banks, you can focus on the individual names, like PNC Financial (NYSE:PNC), SunTrust (NYSE:STI) or Fifth Third (NASDAQ:FITB), but I prefer the ETFs to help avoid business specific risks. The financial landscape is full of land-mines these days. Of course, there are many specialty finance ETFs and for Regional Banks, I like Merrill's Holdr (NYSEARCA:RKH) and the SPDR KBW Index (KRE). With the market stuck in a range, I look towards financials for a new direction and Regionals are the weak spot here. Sure, these are smaller banks, but they hold a lot of weight in the overall market--they are also the main source of so called troubled banks list. There's too much info already in the market on why Regional Banks are weaker, so I wanted to take it a step further and show you the key levels and whether it's a good time to buy or sell (short) these specific ETFs. First, let's understand why this significant underperformance exists - ClustStock via SNL Financial put together a great chart showing the extreme (default) risk that still exists. 

The chart shows that on average Regional Banks have roughly four times as much exposure to trouble loans. As of Q2 of this year big banks had only 5% exposure versus 22% of total capital exposure in smaller regional banks. 


Short-Term Trends 
Earlier we looked at a variety of financial sector ETFs compared to the S&P500 over the past 52 weeks and the performance divergence was clear, but now let's look at last 5 days to help us determine how to play this sub-sector. In the past five days, you'll notice that SPDR Financial Sector (XLF) has outperformed the market with ease while Regional Banks, continue to avoid value seekers. Of course, at some point Regional Banks will recover and probably revert back to the financial mean and that will be first evident in a short-term chart performance like the one below. You can check percentage change charts like this with TrixyChart on - just remember that full functionality (stock scans and customization) is only available with a free account. Finally, let's move from performance charts to looking at KRE alone, this will show us the current direction (or lack there of). 

S&P500 Index (Blue) vs. XLF (Green), IAI (Magenta), KRE (Yellow) - 5 DAYS 

Regional Banks At a Crucial Juncture 
To wrap things up on Regional Banks I though we'd take a look at indicators other than Percent R or Acceleration Bands. I am looking at Bollinger Bands, %B (Bollinger) and Classic MACD, which are essential tools for trades at any level. Percent B is an indicator derived from Bollinger Bands that help you visualize stock price relative to the lower bands. I like this version because it's helpful for pointing out when prices spike outside the bands especially in systems development (coding ease). 

First off, KRE is stuck in a range, no question about that and now it's at resistance (falling back from the top of the range as I write this too). The other main Regional Bank ETF, RKH is also falling back from its highs on Thursday

Based on MACD there as a bullish cross over in early November, however, MACD was not above ZERO - I do not generally trade bullish MACD crosses below the ZERO line as they are usually retests. What's interesting is that MACD on KRE is now above ZERO, which is bullish.  That said, the bearish downtrending channel/range is still intact. Since August the trendline is characterized by lower highs and lower lows so you can expect this to continue unless we break to the upside. Given the proximity to upper resistance, the reaction to Friday's job number will likely tip the pendulum on Regional Banks and, in turn, the market may follow. 

Based on Bollinger and %B we are near the top of the expected range, an updated chart with today's action would show %B reaching the 1.0 level (100% above the lower band or at the upper band). In a trending environment this could signal the beginning of a breakout, however, we know that KRE is in a range favoring the bears so one should expect a multi-day move lower. It's also worth pointing out that volume is decreasing as the price increases (towards resistance), which is considered a bearish divergence. Overall, the Regional Banks need to show much more strength to sway my opinion. There's clearly too much unknown left in these particular institutions, which incentivizes short sellers to enter at the top of range similar to below.  It seems buying the dips has worked in 2009, everywhere except for Regional Banks where the 2008 mantra, sell the rallies, continues to apply. 

SPDR KBW Regional Bank Index (KRE) - Daily w/ Bollinger, %B, MACD

Trade well,
Andrew Hart 

Portfolio Manager - ETF Options Trader 

Disclosure: Short RKH