Promising Shorts in the Financial Sector

Warning signs are popping up across the wide variety of financial stocks affected by the 14-month credit crisis. The negative vibes are so loud, they strongly suggest these issues failed to bottom during the Bear Stearns reversal in March, and will take another leg down before starting a long-term recovery.

Let's consider what hasn't happened, despite all the hoopla after the strong bounce that began on March 17. Most conspicuously, Goldman Sachs (GS - commentary - Cramer's Take) is the only major investment house that's powered above its 200-day moving average, the dividing point between long-term uptrends and downtrends.

At the May 2 rally peak, Morgan Stanley (MS - commentary - Cramer's Take), Merrill Lynch (MER - commentary - Cramer's Take) and Lehman Brothers (LEH - commentary - Cramer's Take) had all failed to reach 200-day MA resistance, despite seven triple-digit-rally days in the Dow Industrial Average. Ominously, Goldman Sachs joined its competitors last Wednesday when it sold off and dropped below 192.50.

Goldman Sachs (GS)

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Source: eSignal

Goldman posted a series of lower lows last week, closing under moving-average resistance for the first time since April. This weak action signals a false breakout that predicts darker days for the financials in the upcoming summer months. But don't expect these instruments to go straight down because recent support layers should break the fall.

For example, Goldman has marked out decent support near 180, the intersection of the 50-day EMA and 10-week basing pattern. A notable bounce should start above that level, but I'm looking for it to fail at or below 200, where the broken rally will attract short-sellers. That contest might offer a low-risk entry for a major downswing toward 160.

Amex Securities Broker-Dealer Index (XBD)

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Source: eSignal

The Amex Securities Broker-Dealer Index (XBD) starts with the big investment houses and then adds in mainstream discount brokers, like Ameritrade (AMTD - commentary - Cramer's Take) and E*Trade (ETFC - commentary - Cramer's Take). E*Trade's bad CDO bets in 2007 are the stuff of urban legend, with the stock getting pummeled into the low single digits in November.

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At the time of publication, Farley had no positions in the stocks mentioned, although holdings can change at any time.

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