Thursday, March 4, 2010
The banking sector is setting up to be one of this year's best short-sale candidates.
On Tuesday, we looked at how the political pendulum is swinging against the banks. Policies that were once supportive of the banking business are now becoming restrictive.
The discount rate is on the rise. The Treasury is going to stop propping up the value of mortgage-backed securities. And the geniuses in Washington are proposing new regulations that will increase the government's power over the banking system.
It's hard to imagine how this doesn't turn out bad for the banks.
Investors can look to profit on this trend by taking a short position in some of the larger "money center" banks. Names like Wells Fargo (WFC) and Bank of America (BAC) come to mind.
Perhaps the best trade, however, is a short sale of the Financial Select Sector exchange-traded fund (XLF). XLF is a basket of about 80 financial-services stocks. Over the past year, the fund has been as high as about $15.50 per share. And its low last March was down around $6.
For the past seven months, XLF has been stuck in a tight range between $13.50 and $15.50.
Here's a look at the chart...
We looked at this chart a few weeks ago. Back then, XLF was threatening to break below its support line at $13.50. A drop below support would have kicked off a bearish trend and likely pushed the stock down to its next support line at $12.
But that didn't happen. The banking sector, and the overall stock market, bounced off support and has enjoyed a nice rally.
Now, however, XLF is approaching the upper end of its range and should hit resistance soon. This is a reasonable spot for aggressive traders to short XLF. The current bounce is extended, and there's resistance just about $0.40 overhead.
A more conservative trader could wait until the stock drifts back lower and punches through the $13.50 support line. That will confirm the downtrend and bring the lower target of $12 per share into play.
Given the anti-banking sentiment in the nation – and the potential profit-diluting effects of new regulations – XLF could fall even farther than that.
Best regards and good trading,
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