Banks Are Better but Still Dangerous

I tossed a few hundred shares of Citigroup (C - commentary - Cramer's Take) into a long-term account two weeks ago as a lottery ticket predicting the government wouldn't let this massive institution go belly-up. The bet paid off, but I don't expect decent returns for several years. In a nutshell, that sums up my thoughts about Citi's peers and competitors after the big holiday bounce.

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Wells Fargo (WFC)

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Source: eSignal

That's bad news for Wells Fargo (WFC - commentary - Cramer's Take), my favorite bank stock throughout 2008. The Sept. 19 buying spike to $44.30 marked a short-lived run to all-time highs and start of a major downturn. The dilutive $11 billion offering last month compounded selling pressure, dropping price to a seven-year low before the broad market recovery.

The bounce has lifted the former leader up to the big dilution gap, which could fill in the next few weeks. However, multiple layers of resistance point to slow and uneven progress for the megabank during the first half of 2009. This is especially true because it's now trading in lock step with the sector's weakest names.

Other money center banks show equal or greater technical damage and should be avoided, except for long-term bets like my November lottery ticket. I recommend that readers still looking for sector exposure should check out the regional players, which continue to outperform the highest-capitalized components.

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People's United Financial (PBCT)

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Source: eSignal

People's United Financial (PBCT - commentary - Cramer's Take) is a Connecticut savings and loan that was added to the S&P 500 index last month. The timely inclusion eased selling pressure while other banks were pounding out their deep lows. This good fortune has kept a bullish tone on the weekly chart, which shows a yearlong basing pattern between $14.50 and $18.50.

The stock has spent the last two months trying to break out above the long base, with mixed results. It appears the September buying spike still holds a healthy population of trapped shareholders looking to get out on rally attempts. This is keeping a firm lid on price development, but I still expect this issue to outperform its peers in the months ahead.

Two entry strategies might work well here. First, buy the stock in small pieces on pullbacks within the basing pattern, as low as $17, and keep a stop loss under $14. Second, stand aside and wait for the stock to break out above the 2007 high at $23.95. Of course, that might not happen until next year, but you'll definitely sleep better at night.

To sum up, banking stocks have bounced off deep lows in a powerful retracement rally, but they still haven't confirmed a final bottom for this bear-market cycle. As a result, any long-side bets in response to the recent buying spike could lose substantial sums of money in the weeks ahead.

However, enough good things have happened to the banking group in the last two weeks to shift from a decidedly negative posture toward a more neutral outlook. This raises the odds for the November lows to hold after a testing period and give way to a stronger and more stable uptrend.

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Know what you own: Farley mentions regional banks. Other companies in the industry include Hudson City Bancorp (HCBK - commentary - Cramer's Take), New York Community Bancorp (NYB - commentary - Cramer's Take), Capitol Federal Financial (CFFN - commentary - Cramer's Take) and Astoria Financial (AF - commentary - Cramer's Take).

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At the time of publication, Farley was long Citigroup, although holdings can change at any time.

Farley is also the author of The Daily Swing Trade, a premium product that outlines his charts and analysis. Farley has also been featured in Barron's, SmartMoney, Tech Week, Active Trader, MoneyCentral, Technical Investor, Bridge Trader and Online Investor. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks.

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