10:03 AM Banking Sector: Regional Banks Verses Large Banks

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I have always believed that it is difficult for broad equity to do well if banks are struggling. Credit makes the economy go, and if banks are impaired, credit suffers. Historically, when bank credit contracts sharply, the economy slows.

Admittedly the relationship hasn’t been as strong over the last twenty years as monetary and fiscal stimulus have made liquidity/credit abundant. Now, with the Fed removing liquidity and tightening and the yield curve in sharp inversion, I suspect the historical relationship is likely to reassert itself.

In this series we will take a general technical look at banks via relative strength ratios. In part 1 we look at ratios between banks and the broad equity market, large and small bans and take a quick look at the yield curve. In part 2 we will look at price charts of the too big to fail banks.

As a reminder: A falling ratio represents underperformance of the numerator security (top) relative to the denominator security (bottom). Conversely, a rising ratio represents overperformance of the numerator relative to the denominator.

Broadly speaking, over the last 25 years index level bank returns have been roughly flat (not including dividends).

Relative Strength Ratios:

BANK/ SPX Monthly: Not surprisingly, banks have been trending lower relative to the SP500 since the early 2000s. The opportunity costs of index level bank investment have been significant.

KRE Regional Banks / KBE SP Bank Index: Monthly: Over the last few months the ratio of regional banks to larger banks has turned sharply lower and is now threatening a breach of substantive support. Weakness below the support in conjunction with the MACD sell signal would suggest a long-term strengthening of the money center banks relative to regional banks.

KRE (Regional Banks) / BKX (Large Banks): Monthly: This ratio looks very similar and adds confirmation to the weakness shown in the KRB/ KRE ratio (I prefer to see multiple ratios confirming a view).

In order to provide a more specific look I summed the four largest (too big to fail) banks, divided the result by 4 and ratioed the result against the KRE regional bank ETF . In this ratio the systemically important banks are MUCH stronger than the regionals. Again the ratio is threatening to fall below a major support zone . The chart makes sense in relative to the events of the last two weeks.

It is interesting that regional banks have been weaker relative to larger banks since August of last year, long before the news of SVB , SIL , and SIG bank made headlines. The relative strength in large banks makes sense in that the systemically important banks control about 40% of group assets, are required to pass stress tests and are in general much safer in a chaotic environment. And, they have more tools to cope with an inverted yield curve.

Its not a coincidence that an industry that depends upon borrowing short (via deposits) and loaning or investing long began to underperform as the 3 month – 10-year yield curve neared inversion. Put simply, when short rates are higher than long rates, there is little or no carry and no incentive to lend. This somewhat exaggerates the problem as many deposits were still pegged at 0.50% or lower. But also realize that many longer-term loans and securities were locked with rates much lower and that mortgage duration has extended significantly as ten year rates moved higher.

Next week we will take a technical look at the big four banks and we will follow that with a more general discussion around banks and what the hell just happened.

And finally, many of the topics and techniques discussed in this post are part of the CMT Associations Chartered Market Technician’s curriculum.

Good Trading:
Stewart Taylor, CMT
Chartered Market Technician
Taylor Financial Communications

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