A Commentary on Technical Developments and Rate Sensitive Financials

This week's trading action in most Financials, Retailers, Homebuilders and Industrials we follow has now traced out what appear to be bottoms that are typical of major lows. Whether these are major lows or not we won't know right away. Tough call as the critical element of time is an issue. Nevertheless, we've had heavy volume selloffs, followed by heavy volume upthrusts. The pullbacks have been minimal in magnitude and met with accumulation. Some will argue that since those are admittedly the industries with the most fundamental problems and have a relatively high sensitivity to macro developments which are not likely to be conclusively resolved, that selling pressure has simply been momentarily suspended. We respectfully disagree.

Of course its the case that some shorts cashed in profits and other late to the game shorts that dove in near lows cried uncle. But is it the case that one should conclude that the recent rally off lows is nothing more than a very oversold rally in a young bear market that should be shorted? We doubt it should be so easily dismissed because it appears to me that there has not only been a sharp retracement of the last move lower; but selling also seems to have dried up. Thats how stocks bottom - not because crazy numbers of buyers come out of the woodwork; rather its because sellers have sold all they wanted to sell and the weakest longs throw in the towel. The price-volume correlation also shifts noticeably.

Today wasnt a particularly huge volume day in the markets; but it was a particularly heavy volume day in some important stocks; namely C, BAC, WB, GE, AEO, JCP, DHI, KBH. All are breaking short-term downtrends and doing so on heavy volume. If that wasnt enough, this is happening in the context of generally poor news, earnings and economic data. Short term trends must become constructive before intermediate trends do so and so on with intermediate and long term. The action has played out very much as we expected and charts are starting to support the idea that the worst is likely to be over for financials shares.

We continue to think when its all said and done, we are likely to be talking about an otherwise greater economic and equity market disaster being averted as a result of aggressive coordinated policy responses. I also think that the huge rate cuts instituted by the Fed are sure to help most banks and brokers, many on the brink of disastrous option ARM resets and also grease the wheels of the credit markets and allow libor rates to gravitate toward U.S. rates and thus help even more.

We think that the banks with extensive branch networks and deposits are helped most, while those with substantial credit card operations like B of A get an added boost and guys like C and JPM that have all that and then a good deal of mortgage exposure may be helped most. Relative to what would have otherwise been the case that is. We don't mean to imply that everything has been fixed in one fell swoop.

Banks with Liability sensitive balance sheets should be helped most. Funding costs/costs of funds have declined significantly (almost overnight). Banks with hefty amounts of spread income are sooner likely to see improved net interest margins and net interest income. The boost to 2H08' profitability will go a long way toward improving industry capital ratios and putting banks and borrowers on the margin in position to refinance and restructure loans is big. Rate sensitive equities are getting a lot of help and reflecting it.

The next few trading days will be telling. Several Banks, Retailers and Homebuilders are now 40-45% off their lows; impressive! Furthermore, many of the leading banks, builders and retailers are approaching difficult technical levels. From a technical perspective, a rest is in order as bears put more shorts on and anyone fortunate enough to capture a good part of the recent move cashes some in. Thus, I'm expecting a pullback in the next few trading days. We'll be looking to get long some quality as this happens.