The Calm Before the Next Bank Storm

Includes: IYF, KBE, KRE, XLF
by: The Sovereign Society

By Eric Roseman

As expected, stocks are charging higher since Wednesday following weeks of protracted selling. That's not a surprise - I've been saying we could see a big rally because the VIX was heavily overbought.

A dose of good news finally arrived last Thursday following Wells Fargo's (NYSE:WFC) Q2 earnings report. A day earlier, State Street Bank (NYSE:STT) also delivered better than expected numbers. And yesterday morning, Bank of America (NYSE:BAC) announced their Q2 profit fell less than expected.

The result, of course, is an incredible rally for financials. Heading into Wednesday's trading, the financials were down more than 55% from their highs last summer. Since financials also represent the largest index weightings for international indices, it's no wonder foreign markets are also running hard along with Wall Street.

On Wednesday, bank stocks posted their best single-day rally since 1989, gaining more than 17%. More of the same is expected today following J.P. Morgan's (NYSE:JPM) numbers.

I'm not sure those numbers are worth uncorking a bottle of champagne for though.

From where I see it, these results are just forecasting worse things to come. All we're seeing now is a dead-cat bounce following weeks of relentless financial sector pounding.

The sub-prime debacle has now largely been written off by most American, Canadian and European banks. But what lies ahead is worse. Consumer loans are now coming undone. Banks are witnessing a significant rise in delinquencies, which I expect to rise dramatically as the economy and employment trends worsen over the next several months.

In a bear market, a dead-cat bounce is typical market action following weeks of pervasive selling. More banks will fail this year, more write-downs will occur and the Fed can't reduce interest rates any further because of the highest inflation in 15 years.

Sell into market strength.

Disclosure: None