The Tide Is Retreating for the Banks

KBW Bank Index -- Weekly eSignal

I'll shift to a more bullish view when the weekly index chart breaks the string of lower highs and lower lows in place since February 2007. In particular, take a close look at the February and September 2008 highs. Now try to convince me the most recent uptick looks any different from those bear-market rallies.

Despite the major percentage gains since the March 2009 low, the July-into-September 2008 uptrend looks far more appealing from a technical standpoint. This weekly chart also makes it crystal-clear that resistance at the 200-day moving average has marked a major line in the sand going all the way back to the miserable summer of 2007.

So I believe the real test for the banking sector will come on the next pullback, when short-sellers and quant funds have a fresh opportunity to drag down prices across the board. That process is likely to be long-lasting and painful because we've been rallying on hope rather than hard data pointing to a stronger and healthier economy.

However, it's also a mistake to expect the bank correction to begin right now, because residual bull momentum could easily support a sideways pattern into early summer. The two-sided environment also leads me to believe the second half of 2009 will be a difficult one, in which the banking sector gives up at least 50% of the rally gains.

That major decline, which should extend into the broad market, could yield a selloff into the mid-20s on the banking index, while the S&P 500 falls to 750. It isn't all bad news, however, because a strong bounce from those levels would support double-bottom patterns that signal the start of a fresh bull impulse lasting several years, at a minimum.

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Alan Farley provides daily stock picks and commentary with his "Daily Swing Trade" newsletter.

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Know what you own: Besides Bank of America, other components of the KBW Bank Index (BKX) include Citigroup (C Quote), Fifth Third (FITB Quote), JPMorgan (JPM Quote), Region Financial (RF Quote), State Street (STT Quote) and Wells Fargo (WFC Quote).