Bank Index Shows Clear Relative Weakness For Stock Market QE Rally

By: Claus_Vogt

The main driver of the stock market rally off the late-August low seems to be the Fed’s relatively clear announcement of quantitative easing number two. Market participants seem to think that another round of extremely easy money will accomplish what the first round couldn’t.

All that easy money is unfounded hope. The economy is no more receptive today to easy money than it was one or two years ago. According to the Fed, quantitative easing will reduce interest rates for longer-term maturities.

Interest rates are already extremely low, so rates are not holding back the recovery. There must be other reasons.

So why is it that the credit engine is still sputtering, more than a year after the recession has officially ended?

Credit Demand Will Stay Weak

Obviously, many consumers are already in debt up to their eyeballs — and above — so banks are rightly refusing to give them even more credit.

Others are on the verge of over indebtedness and wise enough to not pass the boundary to personal bankruptcy.

Then there is another group of consumers who has seen friends or relatives going bust in the aftermath of the housing bubble. They fear the same fate and are staying away from credit. In other words, huge segments of potential credit demand are not willing to take on new debt — no matter how low interest rates fall.

Then we have the business sector, another major part of credit demand. Businesses need credit to finance investments. But they only invest if and when they see attractive opportunities to exploit. If they don’t see attractive investment ideas, they don’t invest and do not need credit — no matter how low interest rates will fall.

OK, that’s the demand side for credit.

Credit Supply Is Also Harmed

On the supply side we have the banking sector. In spite of seemingly strong earnings during the past few quarters, the banking sector continues to struggle. I think many banks have hidden solvency problems and the day of reckoning has only been postponed.

When huge parts of the banking sector were on the verge of bankruptcy, mark-to-market rules were suspended. This enabled the banks to value their assets at fantasy prices. Analytically, banks are huge black boxes. Nobody really knows how solvent they are, how impaired their assets are, or what their real and sustainable earnings power may be. But the market seems to smell a rat.

Bank Index Shows Clear Relative Weakness

Have a look at the following charts. The first shows the KBW Bank Index (BKX), the second the S&P 500 Index (SPX).

As you can see, the BKX has refused to participate in the general market rally of the past six weeks. This pronounced, relative weakness is a very clear negative divergence.

A sustainable rally without the participation of the huge financial sector is extremely unlikely. This is not only technical analysis, but also fundamentally grounded. The banking sector has been a huge contributor to the strong earnings rebound of the S&P 500 stocks.

Instead of positive effects of quantitative easing number two, we may see the negative effects of banking crisis number two. Another round of banking problems will not only hit the stock market via earnings shortfalls of the banking sector. It will also hit the economy as a whole, including taxpayers — when their money again will be used by politicians and the Fed to bail out reckless banks and their careless creditors.

The relative weakness of the BKX may well be a harbinger of both: First, general stock market weakness or the beginning of the next cyclical bear market. Second, another banking crisis accompanied by a recession.

The economy and the stock market are skating on thin ice. The latter is again priced for perfection. There is huge potential for disappointment.

Stay tuned. The clock is ticking — but nobody wants to listen.

Best wishes,

Claus

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