Canadian banks are overbought

Many Canadian investors own bank stocks, or bank ETF’s. That’s because the sector presents a reasonably safe haven for dividend-seekers, along with a history of longer termed capital gains. Baby-boomers, who represent the largest sector of the Canadian population, meet the profile of investors seeking this type of investment vehicle – hence the popularity of the stocks.

Despite the relatively safe nature of the stocks in this sector, and the consistency of dividends, bank stocks (as with any stock sector) can get overbought. I’ve posted a long termed chart below – going back to 1990 – for Royal Bank. RY is the largest Canadian bank, so its a pretty good representative of the group insofar as stock patterns go. Note that this stock (along with the sector) can go parabolic at times. The occurrence of a parabolic move by RY is highlighted on the monthly chart by an overbought Rate of Change Indicator (ROC) and Relative Strength Index (RSI).

A quick note on the two osciallators I have chosen to highlight: The beauty of the ROC indicator lies in its simplicity. It measures the current price to that of “x” periods ago. If price is higher than it was “x” periods ago, the line goes up. If its lower, the line goes down. The RSI is a little different. It measures the sum of the gains vs sum of the losses over “x” periods, then compares the net difference of those two sums to the current day/week/month’s loss (depending on your chart timeframe). It then divides that by the “x” period–and presto–you have an oscillator that is contained between 0-100. In both cases, they are pretty easy to eyeball when looking for  overbought or oversold spikes.

Back to the chart. I’ve chosen to use a 12- period lookback on both of these oscillators. Its a monthly chart, so that means we are measuring momentum on a year-over-year basis. As such, the signals provided by the indicators are “big picture”. Take a look at my highlighted boxes on the chart. These are periods where the stock had very strong – if not outright parabolic – moves. Note that ROC and RSI tends to highlight those periods. Also note that, following such a strong move, the stock has tended to either correct, or experience a period of sideways/ weaker returns. My black arrows illustrate the post-parabolic hangover trends on the chart.

Ok, boys and girls…here are today’s test questions:

• The box on the right side of the price chart illustrates: a) a parabolic looking angle, b) a moderate trend angle, or c) none of the above?
• The 12 month ROC and RSI indicators in the bottom two panes look at this time to be: a) overbought, b) not above their overbought lines, or c) oversold?

If you answered “a” to each of those two questions – you get a gold star on your test. Any of you who answered ANYTHING except “a” – please go sit in the corner and re-think your desire to be a technical analysis-orientated stock investor.

A quick look at the BMO Cdn. Bank ETF

The chart below is a closer view of the equal-weight bank ETF using a weekly chart. I’ve used default lookback periods on the indicators. In a nutshell, we are looking at:

• An overbought sector as indicated by the 16% distance above its 40 week (200 day) SMA.
• Negatively diverging (against price) stochastics and RSI indicators from an overbought level.
• A bearish crossover on the longer termed MACD indicator.
• Comparative strength vs the TSX (3rd pane from the bottom) looking like its rounding over.

Conclusion

The Canadian banks are overbought and momentum is rounding over. The evidence from both a long termed view (monthly chart) and mid-termed view (weekly chart) suggests a sideways or corrective period is likely. Seasonally, the sector can underperform until the end of August. While banks are a great sector to own over the very long term, its likely that the neartermed potential on the group is going to be subdued if not outright corrective.