THIS IS NOT FINANCIAL ADVICE
Last week marked an interesting turning point for the financial sector. Downside in $SPX led to some selling off across the board, and a couple of banks broke technical levels coming into this week, when Stress Test data will finally be released and commented on in full.
On Feb 6th, the Fed released its hypothetical scenarios for the stress test it would conduct. It contained two scenarios (adjusted to three after the Covid lockdown), the Severely Adverse scenario will be our focus today.
“The stress tests include two hypothetical scenarios: baseline and severely adverse. The severely adverse scenario this year features a severe global recession in which the U.S. unemployment rate rises by 6.5 percentage points to 10 percent, and elevated stress in corporate debt markets and commercial real estate.”
If you haven’t realized yet…this is basically right now. Unemployment rate at ~14% (with real unemployment significantly higher), and extremely elevated stress in corporate debt markets and commercial real estate.
The table in the above press release shows hypothetical results of the stress test among the largest players. The potential failures (subject to global market shock/subject to counterparty default) were BAC, BCS, C, CS, DB, GS, HSBC, JPM, MS, UBS, WFC.
The actual results of the stress test will be released on Thursday, but the banks aren’t allowed to comment until AH Monday, June 29
Importantly, we note that the stress-test scenarios were modified to include Coronavirus related shocks, and for the first time ever, banks will be given a stress capital buffer requirement based on the pre-pandemic stress test results.
What would the capital buffer requirement do exactly? The Fed has posited that it will simplify its capital framework by integrating ongoing, non-stress capital requirements and the stress test-based capital requirements under the Comprehensive Capital Analysis and Review (CCAR).
The final rule also modified CCAR by no longer assuming that a firm makes nine quarters of planned capital actions, including dividends and repurchases, under stress. This is important, as banks have suspended their common share buybacks and are in talks to suspend their dividend payments. In layman’s terms, the stress capital buffer requirement would have used the results of the supervisory stress test to determine large firms’ ongoing regulatory capital requirements; can they, with more certainty, survive a downturn based on their balance sheets and probable adjustments to their capital actions?
Returning to the February hypotheticals – many of these banks are projected to fail their stress tests, and sentiment going into the posting of results seems poor. We’ve seen a selloff in banking for the last week, and the breaking of key technical levels along the way. It’s a bit strange that the Fed would not allow these banks to discuss their stress test results until AH…bearish?
Now, as we’ve seen before, the Fed has a tendency to paint a rosier picture than what the actual scenario is, and adjust that afterwards. It’s likely that this will be the case Thursday night, and outlooks will be adjusted bullishly because of buyback and dividend suspensions, as well as hope on the economy reopening. However, until then, I still remain bearish. I should stipulate that this sentiment could reverse very quickly, especially if people start assuming banks look good again. PLEASE KEEP TIGHT STOP LOSSES IF YOU MAKE THESE PLAYS!
My personal bearish observations (charting) coming into this week are below. 4SMA is Blue, 9SMA is Yellow, 18SMA is Red.
- BAC down to $22.50 – 7/2 23.50P @0.54
- GS down to $196.06 (gap fill) or $186.26 – 7/2 195P @4.98
- HSBC down to $22.13 – 7/2 22P @0.16 (this is free fucking money)
- JPM down to $91.33 – 7/2 91.50P @1.80
- V down to $188.43 or $183.56 – 7/2 185P @1.84
- WFC down to $26.90 or $24.03 – 7/2 26P @0.69
- C upside to $54.50 but still in my no-trade-zone; bounce off Bollinger median and 9SMA bounce off 18SMA to 6/10 low
- MS upside to $49.50; bounce off Bollinger median to 6/5 low
My own charts are hyperlinked above. I use Bollinger Bands, MACD, CCI, and triple SMA (4,9,18)/double EMA (12,26). Please do your own DD though. The rest are all in my personal no-trade-zone, so I won’t be trading them this coming week until we see more news/explanations about the results of the stress test.
Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence.