A Big Bad Banking Top

10/13/05 07:43:57 AM

by David Penn

A head & shoulders top appears to be a bearish work in progress over the Banking Index.

Security: $BKX
Position: N/A

Take a good look, investors of the 21st century, at the first bull market of the new millennium.

During the 1990s, even as technology soared, the cognoscenti in financial circles always insisted that it was the financials whose performance would let investors know the true health of the market. This was a pretty clear admission that the US economy (and, to some degree by extension, the world economy) was no longer driven by industry and was in fact wholly wedded to the fortunes of finance.

FIGURE 1: BANKING INDEX. A trendline break in the first quarter of 2005 and a head & shoulders top that began back in the first quarter of 2004 are the two dominant technical features in this long-term portrait of the Banking Index.

Graphic provided by: Prophet Financial, Inc.

Of late, those fortunes have taken a turn for the worse. Looking at the multiyear, weekly chart of the Philadelphia Banking Index in Figure 1, there are two technical features that stand out. The first is the violation of the trendline that marked the cyclical bull market in both the Banking Index as well as the broader stock market. This trendline was broken in the first quarter of 2005.

Interestingly, the break of the trendline also reveals the Banking Index to have been underperforming the broader market. Compared to the Standard & Poor's 500, for example, which topped late in the second quarter of 2005, the Banking Index now appears to have topped in the fourth quarter of 2004. If the truism about the relationship between the financial sector and the economy holds, then the fact that banking stocks have clearly underperformed is a bearish sign for the market and the economy in general.

The other major technical feature of the Banking Index is the developing head & shoulders top. This head & shoulders top has its origins in the fourth quarter of 2003 and appears to be on the verge of a breakdown just as the fourth quarter of 2005 begins. The trendline mentioned actually slices the "head" part of the head & shoulders top in half, with the left shoulder lasting from fourth-quarter 2004 to second-quarter 2005 and the right shoulder -- apparently -- lasting from second-quarter 2005 to fourth-quarter 2005.

Should this head & shoulders top prove valid, the size of the pattern suggests significant correction. In this context, validity most likely would come in the form of a decisive move below the neckline at 93. With a pattern high of 105 and, thus, a formation size of about 12 points, a minimum move down to 81 is what traders should look for in the event of a breakdown. The 81 area, should the Banking Index reach it, might provide significant support insofar as there is old resistance at that level that was left over from the triple bottom of the autumn of 2002 and the spring of 2003.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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