Sunday, January 18, 2009

The Facts

Just the facts please.

More of the same with my concentration on the banking sector index - the BKX. Some really interesting information has been coming out of that area of the market as of late. It is what turned me from overwhelmingly bearish to quite bullish in a matter of days. To make a long story short, the overall market (SPX) is significantly outperforming the BKX; and it appears as though the banking sector is on the verge of being completely washed out (as of Friday). The significance being that the market passed a very large test of the December and November lows last week. The banking sector, however, overshot the November 21st lows by roughly 9 percent. That's amazing relative strength for the overall indices.


It's rare for the overall market to hold up so well in the face of a crashing banking sector. However, this market appears at the moment to have exhausted the contagion of selling pressure that was overwhelmingly evident this fall. This geometry also squares nicely with the posture of the BKX:SPX ratio (see prior posts). From the standpoints of symmetry, the chart looks ready to swing the other way - and by extension, pull the market through some key overhead resistance.

To break things down further and shed some additional color to this thesis, let's look at the facts:

The BKX has crashed and rallied four times in the past year. The BKX, SPX and VIX changes are measured from 1 year prior to date of the low:

BKX Low      BKX/Change      SPX/Change      VIX/Change      BKX Retracement      Rally Trough to Peak

March 10             -34%                 -9%                      +109%                    +14%                             9 Days

July 15                  -58%                -21%                     +88%                      +41%                           19 Days

Nov 21                   -57%                -44%                    +191%                     +37%                             7 Days

Jan 16                    -60%                -36%                   +62%                          ?                                   ?

What's truly noteworthy is the diminished VIX readings accompanying the latest BKX low. The market appears to be saying it has digested the bulk of the financial crisis and is ready to stabilize. If the banking sector can begin to walk again; and more importantly, LEAD, the shorts will be forced to cover in mass.

From a technical standpoint, the BKX has reached its downside targets on both the weekly and P&L charts.

The VIX also looks vulnerable to a strong downside retracement.

The YEN and the USD look very similar as well. Japan's telegraphed intentions last month to intervene in their currency and equity markets could add gasoline to an otherwise combustible mixture.

The McClellan oscillator also appears to be oversold as well as extreme readings evident in the equity put/call ratios.

I am also quite aware of the rare historical parallels this market avails itself too. And quite frankly, the diminished nature of this retracement rally would be without precedent. In December I was in the camp of waiting for another low to reveal itself in the charts, but at this juncture in time with the overwhelming evidence pointing towards the contrary, I will give history the benefit of the doubt. In that instance, we should expect at the very least a 50% retracement of losses. A 60% retracement would also be within the realm of possibility as well.

To date, we have retraced only 19% of the losses that began last August. At the rally's high-point in early January, the market had retraced only 35% of the losses. I find it comforting that this latest weakness retraced on a closing basis 50% of the gains from the November 21st low. From a technical standpoint that is healthy and it appears to be setting the stage for the next leg up. We shall all have a front row seat.

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