The End of Financials Rotation- The Fall of the 3 Pillars?

Yesterday you may remember this post that included sector rotation.


Below is the longer term Sector Rotation chart posted yesterday (linked above).

Note at the bottom, Financials in Green have been coming in to rotation since late December.




This is the near term sector rotation chart posted yesterday

This covers the last 2 days, note what is happening in Financials, they are starting to roll out of rotation. Energy was also rolling out of rotation (2 of the 3 pillars of the market).

3C has been bearish on oil, it defies common sense, but usually 3C contradicts price and common thinking and there is where you find the edge.

Look at what happened to oil yesterday...

And why? Apparently Europe has left the US standing in the cold and decided that they would not impose sanctions or an oil embargo on Iran for at least six months which might as well be never. How did 3C know? It could have only known if the information was already known to smart money, or else smart money was discounting something else we don't know about yet, in ether case, this is one of those situations when I'm glad I followed 3C even when it got a bit sticky.

Of Course this has effected XLE (Energy), one of my so called "3 Pillars". I call Energy, Financials and Technology the 3 Pillars because the market can't go far without all 3 being in rotation. The market can advance without Discretionary or Staples, but not without those 3.

So now lets look at Financials. I entered a BAC short on Wednesday this week (1 day too early and I hinted that I thought I might be a little early), I reason I entered BAC was because of something I saw in JPM (JP Morgan Chase) which reported this morning.

I responded to an email about JPM yesterday being earnings were coming up and I find JPM to look much like the rest of the market. Here are the charts I sent in that email.

 On this daily chart you can see a wedge in JPM, that's bearish and we would as always, be looking for a false upside breakout before it fell apart. It filled a small gap at the yellow line and was close to serous resistance near the red area.

 Here's the wedge, volume and MACD are both correct for a bearish rising wedge and it saw the breakout too which we would always look for on a obvious pattern like this.


Here's that breakout of the wedge not only in JPM, but in the Financial sector more broadly.

 JPM breakout, ended yesterday with an indecisive Doji star. Remember the post just a couple of nights ago about what good follow through should look like, a doji is not good follow through and leaves the breakout as vey suspicious, but we already expected a suspicious breakout from a bearish wedge, it happens 80% of the time as a head fake before a reversal.

Here's the same in XLF

 Now look at the 3C charts and more specifically, during the wedge which you can make out in the price pattern, the 5 min chart leading negative

 The 30 min JPM chart leading negative

And the 60 min chart all leading negative, further casting doubt on the entire pattern.

I also added to the email this:

"These financial co. really play around with window dressing before earnings, they raise their tier 1 capital before earnings. I'll be looking at the 10-K/Q in the foot note section and looking for any changes in the level of "pledgable assets" and any difference between the last qtr and y.o.y, that's the shadow system and they do a good job of keeping it off the books, but that is actually what gave away LEH, their pledgable assets declined 50% y.o.y. which was a warning sign of not only liquidity problems, but that their clients (hedge funds) knew something was wrong and stopped placing order flow through LEH. I read a great article on it, I can probably find it if you are interested, but it's pretty complicated. These are items they are trying to hide and only show up in the footnotes."

As for JPM's earnings this morning?

The headline is a miss on Q4 Revenue, profits fall by 23%

However what I'm more interested in is the shadow banking system that is much larger then the traditional system and it is largely kept of the 10K/10Q earning reports. These shadowy figures can only be found in the foot notes and they have a huge impact. These investment banks, much like Lehman take in business from hedge funds and the like and are able to repleadge assets they take in during the course of that business, which gives them greater leverage. When LEH went down, there was a 50% fall in repleadgable assets, causing a liquidity crunch, but also hinting that those on Wall Street knew there was a problem at LEH. This was similar to what took down MF Global and why their customers didn't get their money back, because the assets MF Global pledged, which were their customers', had a first lien on them by the financial institutions that accepted them as pledgable assets. 

Well I'll be studying the quarter to quarter footnotes as well as the year over year to see if there's the same hint there, but I suspect I WILL find it as JPM's investment banking business was $4.4 billion and down $2.2 billion from the last quarter and down $1.9 billion year to date, that suggests I will find a huge drop in pleadgable/repleadgable assets and that the shadow banking system is falling apart like it did in 2008, which took down Bear Stearns and Lehman.

As for JPM

A close where we are now would verify the head fake breakout.

As it relates to the broader market, the same wedge in JPM is visible in most of the major averages and if you saw my 30-chart 3C post yesterday, you will see that it looks very similar to JPM during the wedge period. In other words, JPM looks very much like a model for the entire market right now.