Reminder: Long-Term Overhead Supply is Not a Myth

While renewed fears regarding Italy's debt and the general European concerns are back in the news, we ought not dismiss the technical predicament of the XLF, ETF for large cap financials. 

Specifically, as we watch major banks like BAC C GS JPM MS WFC all get pounded with violent selling today after recent underperformance, you will note the XLF quarterly chart, below, illustrate that the financials were essentially the last of the major sectors to finally arrive back at the scene of their prior bull market peak before the global financial crisis last decade.

The technical concept of "overhead supply" dictates that when prices makes its initial advance back to the scene of a significant prior peak, a pause is more likely than not, if not an outright rollover. Of the three scenarios we know charts can see: 1) Up, 2) Down, or 3) Sideways, we therefore see the diminished odds of immediate further upside, at least without some initial negotiation of that difficult level. So, we can narrows the odds down to the two latter scenarios in the short-term. 

An explanation for why overhead supply exists is the longs who bought banks in 2007 are now theoretically breaking even, and are much more likely to sell and take some chips off the table after an excruciating roller coaster ride, rather than buy more or hold full positions. Hence, we have "interested sellers" at the prior highs, and we then gauge whether underlying demand from fresh buyers can absorb the sellers. 

Critics of viewing overhead supply on long-term charts, like this XLF, will argue that the prior XLF peak was so long ago, not unlike the dot-com peak for chips and tech in general, that no one even cares anymore that the XLF more or less made it all the way back home. 

But arriving back at the scene of a prior major top can often be a self-fulfilling prophecy, where even non-chartists will glance at those prior highs and decide to trim longs. Moreover, there are many more longs who have been trapped indeed since 2007 but do not care to discuss it, let along admit. 

So when they are finally made whole, to some degree, you can be sure those positions which had been collecting dust will be put out to pasture. 

Going forward, a multi-month pause or pullback in the large cap banks seems more likely than not, with this latest Euro Zone news flow perhaps just as much of an excuse as it was an actual catalyst. 

I will be looking to see whether some regional banks and brokers can defy the selling in the XLF, but it may be too much of a burden for now.