Be Aware of Relief Rallies in Bear Markets

European Financials have rallied 5% from the February 11th lows.  So, is the damage done in the particular group?  It’s too soon to tell as the chart below of EUFN (iShares MSCI Europe Financials ETF) shows the recent move from the lows can be classified as a rally from oversold levels.  Let’s examine further.

The chart below illustrates two important technicals:

1. The RSI (Relative Strength Index) on EUFN was in oversold territory several times the last two months, dropping below a 30 reading.  Price action has only climbed above these oversold levels

2. The price action has not climbed above the red bearish trend line, indicating this chart is still in a bearish trend

EUFN - iShares MSCI Europe Financials ETF

EUFN.png

Source: Bloomberg

Whether or not we are now in a full Bear Market there are lessons to be learned from 2007-2009.  Taking a look back at the price action in US banks over that timeframe shows an overall price decline of 82% (using the KBE ETF).  However, as the Fed & the SEC intervened there were large relief rallies.  For example, as the Fed cut interest rates in the beginning of 2008, KBE rallied ~ 31%, and nearly 66% from low to high as the SEC prohibited naked short selling in financials.  See below chart.

KBE - SPDR S&P Bank ETF

KFC.png

Source: Bloomberg

The recent European stock rally was ignited on Monday by Mario Draghi stating that the ECB won’t hesitate to act if price stability threatened.  As we saw during the 2008 financial crisis, there were often bear market rallies after central bank actions or the possibility of central bank actions.  In my opinion, since the fundamentals of the European banks have not changed and the recent rally was from oversold levels it may be a good opportunity to use this bounce to add a short position in the space.


CF’s trade:

Go short EUFN outright or the purchase the July 11/14 debit put spread @ $0.70





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