The Buffett Bank Bottom?

 | Aug 26, 2011 | 12:45 PM EDT
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Did Warren Buffett stop the bleeding? The banking sector has been hammered, and shares of Bank of America (BAC) in particular have been hit hard, falling to a two-year low of $6.01 per share on Tuesday. The question is, did yesterday's $5 billion dollar deal by the Oracle of Omaha mark the bottom of a long slide in the banking sector in general and Bank of America in particular?

Source: TradeStation

A look at the Bank of America chart seems to indicate that the worst may be over for the embattled financial behemoth. Yesterday's action helped to shape a bullish double-bottom formation on the stock, punctuated by the high volume seen both this week and on the previous bottom from earlier this month. One word of caution: We may need to see a fill of yesterday's opening gap before Bank of America shares can begin the long road to recovery; a fill of that gap would take us to $7.05. While that might make an interesting point to initiate a highly speculative long position, my plan is to wait for some positive action in the overall sector.

While yesterday's action was all well and good for Bank of America shareholders and longs, how does it translate to the overall sector? The SPDR KBW Bank ETF (KBE) may also have formed a bottom, but its appearance is not as impressive due to a less-dramatic increase in volume, and to the brick wall that appears to lie ahead at $20. Yesterday's action took KBE to a high of $19.98, where it promptly reversed.

Source: TradeStation

This ETF consists of some of the biggest names in the industry, such as JPMorgan Chase (JPM), Wells Fargo (WFC) and Citigroup (C), in addition to Bank of America. The chart of KBE is telling us that a break above $20 could mark a potential turning point in the fortunes of these downtrodden giants of finance. A close above $20 for KBE, especially if it occurs on high volume, would be the required signal before I'd consider entering any long positions in individual stocks in this sector.

If and when the banking sector manages to pull itself above this resistance level and reach a short-term high, which banks should we buy? We have to be objective; instead of just mindlessly buying the "story stock" of the day, we have to ask ourselves, Is there something better in this sector that we should be watching? It's time to sift through some charts to make sure that we're getting the best trade for our money.

The search for strong stocks in a weak sector sometimes leads us off of the beaten path, but I do find that the road less traveled is often the most rewarding. I still believe that regional banks have more potential than the big multinational names. Remember 2008, when everyone learned just how interconnected all of these too-big-to-fail financial institutions really were?

Let's not forget about the sovereign debt troubles in Europe and the possibility of further damage to SocGen, Deutsche Bank and the like. When I think about the big U.S. names mentioned above, I often wonder about the hidden risk of exposure to these European banks.

And so I look to the regional banks, and one stock chart that I'm quite fond of is First Source (SRCE). Here's a stock that has simply ignored the headwinds of both the market and its sector and marched higher.

Source: TradeStation

Even if it's true that a rising tide lifts all ships, wouldn't you want to be on a ship that's sailing along just fine on its own? When the tide finally does roll in for the banking sector, the ones that held up best during the storm should continue to perform.

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