Will PacWest Bank Be the Next Fed Casualty?

May 4, 2023  |  Michael Reilly

In case you missed it, the FOMC met yesterday, and as expected, raised rates by .25%.

Also as expected, Fed Chair J. Powell outlined the Fed’s stance moving forward with regard to future rate policy.

What was not expected was Powell’s opening statement.

Chairman Powell literally opened his press conference by stating, “Good afternoon. Before discussing today’s meeting, let me comment briefly on recent developments in the banking sector. Conditions in that sector have broadly improved since early March and the U.S. banking system is sound and resilient. We will continue to monitor conditions in the sector. We’re committed to learning the right lessons from this episode and will work to prevent events like these from happening again.

“The U.S. banking system is sound and resilient”?!

Should we be reading between the lines?

Is the Federal Reserve completely inept or is Powell trying to put one over on us?

Here’s a tweet I sent following JP’s comments.

The mere fact that the Fed chair thought it necessary to emphasize the U.S. Banking system is – as he puts it – “sound and resilient,” leads me to believe it’s anything but.

Sure, too big to fail, JPMorgan will be ok. But how about the others?

It didn’t take long for the truth to emerge.

Within hours of the Fed rate announcement and Powell’s comments, another California bank appears to be heading for the gallows.

Bloomberg News reported that Pacific Western Bank was “considering strategic options including a sale.”

The news resulted in shares of Pacific Western Bank falling 60% in after-hours trading.

It didn’t take long for other regional banks to join the party, as five other banks joined PacWest’s decline, all experiencing double-digit losses in after-market trading.

Maybe the question we should be asking is: How much more of a systemic problem will this become?

Will this spill over into other parts of the market? To be clear, it has not as of yet.

The S&P500 and Nasdaq100 just closed the month of April at the highest levels in a year. I’ll have more on this in our upcoming monthly chart review due out in a few days.

Here’s something you may not know about these smaller banks. A lot of these banks have been in trouble for a while now.

Take a look at the weekly price charts of Regional Banks (KRE) and Community Banks (QABA) going back to 2020. Textbook major topping patterns – rolling over and breaking through prior support.

Are these the proverbial canaries in the coal mine?

If that’s the case, then we should see the selling spill into other areas of the market.

And that probably starts with the broad U.S. Financials sector index XLF.

XLF doesn’t look as bad as Regionals or Community banks, but it’s not showing strength either.

You need to know this: The pre-covid highs and the low from 2022 are the line in the sand.

Investors do not want to see a break below that support line.

Nothing good happens to this market if Financials break last summer’s lows.

To illustrate just how important that $32 level is to the broader financial sector, here’s a monthly chart of XLF going back to the 2008 highs.

The 2008 highs in XLF are the same levels as the peaks in 2018 and 2020, in addition to acting as support last summer.

So yeah, these areas of previous support and resistance are important to watch.

If there’s more trouble to come, you’ll see it here with XLF breaking down.

And a break below $32 and all bets are off.

Remember: We don’t have bull markets in the U.S. without financials participating.

If you’d like to talk more about how we can help you navigate these volatile markets easily, so you’re ready for whatever comes next, schedule a free 1-hour consultation with one of our advisors.

Get Our FREE Guide

How to Find the Best Advisor for You

Learn how to choose an advisor that has your best interests in mind. You'll also be subscribed to ADAPT, Avalon’s free newsletter with updates on our strongest performing investment models and market insights from a responsible money management perspective.

Avalon_NewGradient_24Feb22 copy