Take a look at the chart below. It shows the FTSE 350 Banks index (blue line) versus the FTSE100 (red line), from 3 March to date. The UK banks have rallied nearly 60% - their best spell in over three months, and it’s still going.
The banking sector’s ‘pseudo’ rally...
Source: Google Finance
Note the rampant outperformance of bank shares in this bear market rally. And this is exactly the problem.
You see, there’s a reason for this...
Previously, investors were short selling banking shares. That’s when you borrow shares from an institution or other big investor, then sell them, betting that they will fall. But you need to "close" the short position by buying back the same number of shares and returning them to the lender.
So when the price does fall, you buy back the stock at the lower price, return it, and make a profit on the difference. And this is what is driving that bear market rally.
Don’t forget that the slew of government programs to shore up the banks has also led investors to bid up financial shares. But the sector as a whole remains hugely unstable and we’ve yet to see any concrete turnaround in fundamentals.
So be careful. While currently in the green, bank shares aren’t likely to bring about a sustained market recovery.
Follow-up reading: Theo Casey of The Fleet Street Letter explained this phenomenon in a recent essay for The Right Side. Click here to access Short Sellers and How You Can Use Them for free.
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