This Sector is About to Plunge
If there is one thing the banking sector hates, it is a flat yield curve. And the way the bond market is acting right now, there seems to be one on the way.
The traditional banking business borrows money at short-term rates and lends it out at long-term rates. Currently, the spread between the benchmark 10-year Treasury rate and the 2-year rate, which is the proxy for the yield curve, is at levels not seen since late 2007.
For context, the spread went negative in late 2006, meaning the yield curve was inverted. Economists note that an inverted yield curve is often a precursor to a recession, and in the stock market at that time, the writing was on the wall.
While big international banks have diverse business interests, smaller banks still rely on lending money to individuals and businesses, making their fortunes much more intimately connected to the yield curve. If there is no money to be made borrowing short and lending long, their profits will suffer.
The SPDR S&P Regional Banking ETF (NYSE: KRE) is a good representation of the sector, and we can see in the chart below that it sports bearish technicals.
It experienced a nice rally off its February lows, along with most of the market. However, it only regained about two-thirds of what it lost since the late-2015 highs, while the broader market S&P 500 made a full recovery during that time.
In other words, KRE lagged the market and continues to do so. Investors will recall the mantra of buying the strongest stocks in the strongest sectors to beat the market. The converse is true in that the weakest stocks in the weakest sectors are the most at risk for further losses.
There is more to a bearish forecast than just lagging the market, though. And when we look at other indicators, we see a rather well-rounded case to support further declines.
After two attempts to breach its 200-day moving average in the past three months, KRE fell back below it — hard. It also broke down below the rising trendline that supported the 2016 rally on heavy volume.
This should not come as a surprise considering on-balance or cumulative volume barely budged during the rally. This indicator, which keeps a running tab of volume changing hands on up days minus volume on down days, should mirror price action. That’s because it is a proxy for money flowing into a stock or ETF, and here we see no money flowing in to sustain the advance.
Even worse, while KRE is still near its highs for the year, on-balance volume made a new low. This suggests sellers are firmly in control and the path of least resistance is to the downside.
Currently, a potential Brexit (the United Kingdom leaving the European Union) and the Federal Reserve’s desire to hike interest rates in the face of a bond market that makes a good case for a pending recession are raising fear levels and flattening the yield curve.
If the market’s fears are not realized, then conditions for KRE may improve, but that is just speculation at this point. With the evidence now on the charts, the outlook for regional banking stocks is negative.
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