The way bank stocks are behaving on earnings is making me nervous about the financials

One of the most encouraging things you want to see in the equities market is when a stock rallies in the face of bad news.

That usually tells us that the bad news is priced into the stock’s price. Similarly, one of the most discouraging things to emerge in the market is when a stock, or a group, reacts poorly to good news; this tends to indicate that the good news is already priced into the stock, and there aren’t any buyers left to take the stock higher.

This is exactly what we’ve seen in several key bank stocks recently, like JPMorgan, Citigroup and Goldman Sachs, which gives me pause about the group as a whole.

All three banks reported strong earnings, but in each case their initial rallies reversed, and the stocks fell considerably. Even Bank of America reversed its gains on Monday, even though it didn’t fall quite as far as its aforementioned peers.

What's to blame?

Investors have given some blame to the rise in credit card delinquency rates, the fall in loan demand, as well as the ever-flattening yield curve. Remember, the spread between the 2- and 10-year Treasury yields just hit a fresh 11-year low, to less than 45 basis points (less than half of 1 percent).

Whenever that measure falls below 50 basis points, an inverted yield curve almost always follows before long, and with that comes recession concerns. This could well be the reason for the poor performance in the bank sector.

The next move

Having said all this, it’s important to bear in mind that the big bank stocks have the habit of declining when they report earnings, and this is another reason why I’ll be watching them so closely this week.

If the group can regain their footing and rally back toward their year-to-date highs, this will prove to be quite a bullish development and I may become more optimistic.

However, if the stocks continue to slide, this is going to raise a yellow warning flag on the group, as the KBE (a widely followed bank exchange-traded fund) is getting close to its trend-line going back to mid-2016. As such, the next week or so should be critical for the bank stocks.

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