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Are Big Banks In Big Trouble?

|Includes: AA, BAC, C, GS, JPMorgan Chase & Co. (JPM), MS

With earnings reports and possible credit downgrades looming ahead, big bank stocks will need to weather short-term headwinds in order to recover and again lead the markets higher.

With Alcoa, Inc. (AA) set to kick off earnings season after the close today, many are even more interested in the earnings from the big banks. The focus intensified in late March when ratings agency Moody's said that it will decide in mid May whether to lower the credit ratings of 17 global financial companies.

The most vulnerable seems to be Morgan Stanley (MS), which could have its credit rating lowered to well below that of main rival JPMorgan Chase (JPM). Bank of America (BAC) and Citigroup, Inc. (C) are also being watched closely.

A credit downgrade could have a serious impact on future earnings, as the banks would be required to put up more in collateral to back trading contracts. They also could lose business from some of the large mutual funds, which may be restricted from doing business with firms who have lower credit ratings.

JPMorgan Chase (JPM) will be the first of the big banks to report earnings, with the announcement due before the opening on Friday, April 13. The other three will report earnings next week. The shares of all four of these banks have corrected from the March highs, and identifying the important support levels before the upcoming earnings reports could give some clues about how the stocks will fare over the next few months.

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Chart Analysis: Bank of America (BAC) was one of the first quarter's star performers, but the stock is down 11% from the March high of $10.10. The 38.2% Fibonacci retracement support is at $8.13.

  • The chart has important chart support at $7.52, which also corresponds to the 50% retracement level
  • Clearly, the 61.8% support at $6.90 needs to hold on any correction
  • On-balance volume (OBV) has been acting stronger than prices and has not dropped far below its highs
  • OBV is now testing its weighted moving average (WMA) and has first support at the uptrend, line b. The longer-term support, line c, goes back to the positive divergence that formed in December
  • Initial resistance for BAC is now in the $9.35-$9.80 area

Citigroup, Inc. (C) is also down 11% from its highs, and the daily chart looks much less positive than that of Bank of America.

  • Citigroup is already reaching its first area of chart support, with the 38.2% Fibonacci retracement support at $31.94
  • The more important 50% support is at $29.93 with the daily uptrend, line d, in the $28.60 area
  • Daily OBV has dropped below its weighted moving average but is still well above the support from both its February and March lows. A drop below those support levels would weaken the outlook
  • Volume has been low on the recent decline and the OBV is well above support at line e
  • There is initial resistance now at $34.80-$35.50 with stronger resistance now at $36.50-$37

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Morgan Stanley (MS) is reportedly in danger of having its credit rating dropped three notches, which would put it well below the credit rating of both Goldman Sachs (GS) and JPMorgan Chase (JPM).

  • The daily uptrend, line a, was broken over the past two days, and MS is already close to the 38.2% Fibonacci retracement support at $17.51
  • More important 50% support is at $16.37 with the longer-term uptrend, line b, at $16
  • Daily OBV formed a negative divergence at the recent highs, line c, and has now violated support at line d
  • A break of the longer-term OBV support at line e would be more negative
  • The daily chart has a band of resistance in the $18.50-$19.40 area and more important resistance above $20

JPMorgan Chase & Co. (JPM) could also be downgraded although it currently has the highest credit ranking of these four big banks. JPM peaked on March 27 at $46.49 and is now down 5.6% from those highs.

  • The daily uptrend, line e, is now at $40.80 with the 38.2% retracement support at $39.46
  • The late-October high and the 50% retracement support are in the $37.54-$37.29 area
  • Daily OBV has dropped back below its weighted moving average but has long-term support at line g
  • JPM currently yields 2.7%, which is considerably more than the other three banks
  • First resistance is now at $44.70-$45.40 with stronger resistance at $46

What It Means: The financial stocks will likely play an important role in moving the markets higher once the current correction is over. After the impressive first-quarter performance, I expect to see a drop at least back to the 38.2% support levels. The volume has been low on the recent decline, which is a positive sign.

Since several of these bank stocks are already down more than 10% from the recent highs, a rebound is becoming more likely. It will be important to see if the volume expands on the next rally, because that would be a positive sign.

How to Profit: There are no new buy recommendations for now, but for those who are currently long Morgan Stanley (MS), consider lightening up on that position on any move back to the $19-$19.40 area since that stock looks the most vulnerable of the group.

JPMorgan Chase & Co (JPM), on the other hand, looks the most interesting, and I will be watching it closely if it gets back to the $39.50 area.