By Jim Donnelly
Despite overbought conditions on long-term monthly charts, the Keefe, Bruyette & Woods U.S. Bank Index (BKX) broke solidly above key trend line resistance at 57.60 and appears to be in position to extend a lot higher.
No doubt, hints from Fed Chairman Ben Bernanke that the Fed could pare back on its monthly treasury and MBS purchases (which now total $85B monthly) in coming sessions (if economic conditions warrant it) caused the treasury yield curve to steepen with treasury 10-year notes closing Friday’s session above the 2% level.
The economic conditions required to cause such a paring back of Fed purchases would clearly have to be reasonably good for FMOC to consider it. Such a premise combined with a steeper yield curve would clearly be welcomed news for banks and bank stock holders alike since in theory, greater lending margins would likely increase bottom line profits.
Moreover, a steeper yield curve would also encourage banks to make more loans which, in turn, would likely lead to an increase in domestic GDP, employment and economic activity in general. That being said, the ironic twist to this rosy economic outlook is that it could cause investors to reduce equity purchases for fear of a limited quantitative easing (QE) participation going forward.
While this irony could result in a period of investor retrenchment, it is interesting to note that the Dow Jones Industrial Average and the Dow Jones Transportation Index are both approaching long-term trend line resistance levels at 15,840 and 6,590 respectively with the Dow Jones Utility Index already having pulled back from a test of its key resistance at 537.
Although this scenario does fall into the “sell on good news” category over the short-to-intermediate horizon, it does remain positive for both the economy and investors alike longer-term. In addition, it also suggests that bank stocks should begin to “outperform” as a market sector in coming months.