Just how strong is the rally in banking stocks? Yes on the surface it appears that banking stocks are making a comeback with clear technical breakouts despite the barrage of negative news that persists over bad loans and potential bad loans……….however just what is the depth of the rally in banking stocks? To gain an understanding of just how broad based the advance is we look to the performance of the S&P 600 Banking index. From the charts below one can observe that small cap banks have yet to show any meaningful technical breakout and until they do we remain somewhat sceptical of the behaviour of large cap banks. We find that underlying trends in stock markets become far more apparent when observing the behaviour of small cap sectors. Case in point, note the behaviour of small cap banks in early 2007, if there was any doubt as to what was going on with large cap banks during this time it was quickly answered by the behaviour of small caps.
S&P 500 Bank Index
S&P 600 Bank Index
Will the S&P 600 Banks index breakout (i.e. above 250)? Although we tend to believe things when we see them, we think that there are better than even odds of a bullish breakout. One of the biggest drags the finance/banking sector has been the housing sector, with home builders and mortgage finance stock bearing the brunt of if over the last few years. Yet an index of homebuilders and mortgage finance stocks (MFX) has already broken higher.
KBW Mortgage Finance Index
Yes we know that there are a power of reasons as to why banking/homebuilder/mortgage finance/REIT stocks will not go up over the coming weeks/months but these reasons are currently at odds with what is occurring within the market. If you want a great contrarian trade you could do a lot worse than to take a closer look at finance stocks, and as John Templeton famously put it “invest at the point of maximum pessimism”. Close friends and family would consider an “investment” in US home builder and mortgage finance stocks as complete madness – perhaps that’s what it takes to find value!
