Let's look at a 3 year picture of the S&P 500 versus the Banking Index today.

Why is it important to look at the Banking Index at this time?

The answer is, "because of mortgages, the home building industry, and a credit contraction."

First, the home building industry caved in, but our economy seemed unaffected.

Now, sub-prime lenders are in big trouble with default rates rising. As bad as it is, it will get worse towards the end of the year when over 1 trillion dollars in mortgages will initiate substantial increases in monthly payments.

It worried Federal Bank Regulators enough to want credit restrictions deployed. Sub-prime loans weren't a problem in 1994 when less than 5% of all mortgages were sub-prime. Now, 1 out of every 5 mortgages are sub-prime loans.

I recently heard that over 50% of sub-prime loans were "0% down" loans during the past year. With no equity cushion to protect the lenders, this could become a serious problem. Already, the rising delinquencies on sub-prime loans are forcing lenders to set aside more reserves against potential losses.

In the words of the Regulators, "Sub-prime loans may pose an elevated credit risk to financial institutions."

Banks are now starting to worry. Americans have had a negative savings rate since last year. That means, that their monthly paycheck isn't enough to pay the bills, credit cards, and loans that they have. It means that they have to dip into savings, or add more debt to their credit cards. So now, banks are getting tougher on who gets a loan, and raising the required down payment amount.

This raises two problems. The first problem was the spiking default rates. The second problem is now a contraction in credit, and that will slow the economy down further.

So, as an investors, it would be prudent to start following what happens to the Banking Index.

Below is a comparative chart for the S&P 500 versus the Baking Index going back to 2003.

Note that the S&P had a 3 year rising channel. It broke above it, and recently had a hard drop. But ... the drop took the S&P down to its upper channel's support.

With all the loan problems surfacing, the Banking Index didn't fare as well. Its drop took it below the upper channel's support ... AND below its next support line. This spells more trouble for bank stocks, because the next support is now the lower channel line.

The bottom channel support is critically important on the Bank Index. If the index breaks below that level in the coming weeks, then you will see a much lower stock market.

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