Trading Financials

Several people have written to ask about the possible nationalization of banks, what it would mean to investors, and whether I’m out of the sector because of the risk.

Nationalization means different things to different people.

If we’re talking about the government taking over the entire financial sector for the country, processing loan applications, sending out credit card bills, handling foreclosures, and so on, then I doubt it’s much of a risk at all. The U.S. government lacks the administrative talent to handle such a wholesale takeover.

If we’re talking about the government taking majority ownership of some key financial institutions, then I think it’s possible and I think it’s possible that equity investors in those institutions will be wiped out, as they were with Lehman Bros.

If we’re talking about the government just taking so-called toxic assets off balance sheets, or setting up a bad bank to handle all the garbage created by international financial supermarkets in the past two decades, then I think it will be awful for taxpayers but finally the relief needed to get lending confidence going again. This looks like the route favored at the moment, but moments come and go and none among us knows what shape the solution will take.

As for whether I’m out of the sector: no. I think it’s good for a long trade and that’s how my money is positioned. Paraphrased from yesterday’s note to subscribers on this subject:

Shorts are nervous here. Their side has had it too easy for too long, and they know it. With so much cash on the sidelines, with so many new government people in key positions, with so much fervor to get something done, the risk of a rocket-fueled rally is high.

It happens to be highest in the financial sector. Financials are down dramatically and are known to be the main problem, which is why they’re in policy crosshairs and first on the new administration’s to-do list.

This does not mean, however, that all is well in financials. It is not a belief that the worst is behind us that has our money riding on a bounce. We need just the faintest glimmer of hope to see our investment move higher. It gained 7.5% on Friday’s bad news. What can it do on another day’s good news? Doubling after a few days or a week of good news is not out of the question.

For more on that, we turn now to our trusty old RSI measure. We don’t know what Obama or Geithner or Congress will do next, nor when. What we do know is that the financial 2x UYG is sitting on an RSI score of 34 after turning up from a 9-day drop of 55%. Its MACD trendlines have turned up from Tuesday’s lows, too. If we had read not a single line of news but saw just the chart and these readings, we’d have no doubt about buying into the sector.

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