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Financials Keep Going Up: What's Up?

We have noted how hedge funds who were short financials going into April got blown out at the end of the month when neither earnings nor the stress test caused a selloff in banks.

That created massive short covering and a new bank rally. The Bank Index is up 31 percent this month while the S&P 500 is up 5.8 percent.

Volumes have been TITANIC in the big bank names in the past week; Citi now routinely trades over 1 BILLION shares a day. Who's buying?

My sense, based on discussions with trading desks, is that:

1) Hedge funds that were short are continuing to cover their positions, so that short positions are much lower now than a month ago.

Short interest in bank stocks peaked in March, and has been declining since then. We will get fresh short-interest data on Monday, which should help clear this up a bit.

2) Some mutual funds ("the city of Boston" as hedge fund traders derisively call them) were also massively underinvested in financials and their plain-vanilla buying is also driving this leg of the bank rally.

So where do we go from here? Nonfarm payrolls are out, stress test is out, earnings are out. What are the catalysts for the market in the next month?

To be sure, there are still issues: Chrysler and GM are still playing out, for example.

But the slight news vacumn now that the big ticket items above are out are causing traders to debate whether to stay with the rally, or take profits.

There is no consensus, and the technical signals have been confusing as well. There's been signs that the rally is faltering as we have seen selling into rallies for the past several days, even as the economic news was a bit better than expected.

Today's strength in financials and commodities is helping the bull position.

The main worries on trading desks:

1) Rising bullishness

2) Rising Treasury yields, which could derail attempts to keep mortgage and other consumer rates low.

3) Economic news worsening: already the budget assumptions of 8.1 percent unemployment is being exceeded by the 8.9 percent unemployment rate for April, which might require banks to raise additional capital beyond the stress test.

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