Chart Advisor: A Big Week for Big Banks

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By J.C. Parets & All Star Charts

Tuesday, 17th January, 2023

1/ A Big Week for Big Banks

2/ Materials Make New Relative Highs

3/ Looking Good Under the Hood

4/ More Bullish Evidence for Stocks

Investopedia is partnering with All Star Charts on this newsletter, which both sells its research to investors, and may trade or hold positions in securities mentioned herein. The contents of this newsletter are for informational and educational purposes only, however, and do not constitute investing advice.

1/ A Big Week for Big Banks

The largest banks in the U.S. are kicking off another earnings season. On Friday, the retail banking giants, JPMorgan (JPM), Bank of America (BAC), Citigroup (C), and Wells Fargo (WFC) all rallied on the heels of their reports. Today, the big investment banks Goldman Sachs (GS) and Morgan Stanley (MS) experienced mixed reactions to their reports. 

With earnings from the six largest U.S. banks now in the books, let’s take a look at our custom equal-weighted “Big 6 Bank Index” overlaid with the SPDR Financial Sector ETF (XLF).

Source: All Star Charts, with data provided by Optuma

Our logic here is simple. Before we can trust a breakout from financials at the index level, we would need to be confident that the largest weightings and most important stocks in the sector are on board and participating to the upside. The six companies in our index are not just the largest banks in the U.S., they are also the largest components in the financial sector outside of Berkshire Hathaway, with the exception of Citigroup.

Bulls want to see these big banks catch higher and confirm the price action in XLF. With earnings now out of the way, our custom index could follow XLF and resolve higher from this massive basing pattern.

2/ Materials Make New Relative Highs

The relative trends in value-oriented areas continue to accelerate higher as we move into mid-January.

The chart below shows the Small-Cap Materials ETF (PSCM) breaking out of a multi-year base relative to the S&P 500 (SPY).

Source: All Star Charts, with data provided by Optuma

Not only is this ratio reaching its highest level since 2019, but momentum (as measured by the 14-day RSI) is getting overbought to confirm the price action. This is evidence that buyers are becoming increasingly aggressive in favor of small-cap materials.

As long as this breakout sticks in the PSCM/SPY ratio, we could expect materials stocks to continue to outperform the broader market for the foreseeable future. We’re seeing similar relative strength from large caps.

3/ Looking Good Under the Hood

There are a number of ways to measure breadth, or the internal strength of markets. For example, we can look at advance/decline statistics, percentage of new highs, percentage of stocks above a moving average, or we can just look through thousands of individual stocks. Whichever you consider, since the start of the new year, breadth has improved in a significant manner.

The chart below illustrates this as the percentage of stocks that are 20% off their lows is now higher than the percentage of stocks that are 20% off their highs. 

Source: All Star Charts, with data provided by Optuma

If you use 20% as your measure for a bull or bear market, this would mean that more stocks are now in new bull markets than stuck in old bear markets. The last time this relationship flipped for a sustained period of time was in the second quarter of 2020, just as the bull market was picking up steam. We might be entering a similar environment today.

4/ More Bullish Evidence for Stocks

The U.S. Dollar Index (DXY) posted a death cross last week. This is when the 50-day simple moving average (SMA) undercuts the longer-term 200-day SMA. 

This could be taken as confirmation of the bearish trend reversal in the DXY and has historically proven bullish for U.S. stocks. 

Source: All Star Charts, with data provided by Optuma

There are three instances of the 50-day crossing below the 200-day moving average over the past five years. Aside from last week’s signal, the May 2017 and July 2020 events were great times to short the dollar and buy stocks.

We’ve run the numbers. Since 1980, the U.S. Dollar Index has registered 28 death crosses. Five, 10, and even 63 days out from a crossover signal, the S&P 500 historically provides mixed returns with positive gains occurring 57.14%, 51.85%, and 66.67% of the time, respectively.

But when we move further out on the time horizon to 126 trading days (six months) and 252 days (one year), the returns are quite impressive at 85.19% for both. The study highlights a bullish environment for stocks following a significant bullish-to-bearish trend reversal in the U.S. dollar such as the one that just occurred. 

Originally posted 17th January 2023

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