Financials May Be Ready for Another Dip

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The bank sector is holding a bearish technical configuration, and the group looks vulnerable to further downside price action. The financial and banking stocks have been attracting value investors at this level as they try to get in front of a potential rebound, while bypassing the extended commodity-related names. We don't doubt that this group does indeed look attractive on a valuation basis, but the price action in the sector suggests to us that the group is ready to continue the primary downtrend.

S&P Bank Index

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The S&P banking sector (BIX) has formed a large bearish triangle within the primary downtrend channel. This pattern is a bearish continuation pattern, which usually suggests a resumption of the primary trend is imminent.

We're seeing a similar pattern and price configuration in the Nasdaq Community Bankers Index (ACBQ), which shows that even the small-cap banks are under price pressure. The NYSE Financial Index (NYK) has rallied sharply off of the March lows, but the move in the index still looks countertrend in nature. It has not violated the downtrend channel and looks very similar to the countertrend move we saw in the group last summer. The internal indicators remain very weak, and liquidity continues to move away from the group.

Value-based traders may be interested in the sector, but the trade lacks conviction, and money is not flowing toward the group. The price action in the related indices remains bearish and suggests we may have "another shoe to drop" in the group.

We would need to see a sharp rally higher in these stocks that breaks the primary downtrend channels to nullify the bearish technical configurations in these indexes. A rally in these names is the lower-probability scenario at this point, and we remain bearish on the sector.

Merrill Lynch Regional Bank HOLDRs

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Traders looking for a continued decline in the banking sector can short the Merrill Lynch Regional Bank HOLDRs ETF (RKH - commentary - Cramer's Take). The RKH has the same bearish triangle forming within the downtrend channel that we are seeing in the other banking indices.

It's possible for traders to get short the RKH once it breaks support at $114.40. A stop-loss on the trade could be placed at $126, which would be a violation of the downtrend channel and suggest that a reversal has taken place. The action in this group suggests to us that the toxic effects of the subprime financial crisis have not cleared the system completely, and liquidity is still moving away from the banks.

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At the time of publication, John Hughes and Scott Maragioglio had no positions in the stocks mentioned. Hughes and Maragioglio co-founded Epiphany Equity Research, which has developed and utilizes proprietary tools to identify and track liquidity changes in the market indices and sectors. Hughes advises numerous asset managers, hedge funds and institutions managing in excess of $30 billion. Maragioglio is a member of the market technicians association (MTA) as well as The American Association of Professional Technical Analysts (AAPTA) and holds a Chartered Market Technician (CMT) designation. Maragioglio has also served on the board of directors of the AAPTA.