Financials were the best performing sector in the U.S. market after a strong earnings season in mid-July. But as so often happens in markets, investors and traders had clearly bought ahead of that good news, and ever since earnings season ended for the sector, financials have lost their leadership perch.
Financials are important to watch as an indication of broader risk sentiment. In my experience, since financial companies have complex balance sheets that are very hard to appropriately value, their movements over time are based even more on market psychology than other sectors of the market where fundamentals are easier to assess.
In that sense, XLF’s recent underperformance is worth watching as a sign of whether this correction continues over the next month. Yesterday, it was the worst performing sector in the market on the biggest down day since June 20th. XLF broke its 100 day moving average for the first time in 2013:
The 200 day moving average and the June 2013 lows come into play between 18.25 and 18.50. But perhaps more concerning for the overall market is how financials have broken their outperformance uptrend vs. the S&P 500 that had been steady over the last year. Here is the ratio of XLF / SPY:
The break of this uptrend of outperformance is concerning as the market searches for new leaders to take it higher. The consumer discretionary sector has held up better on a relative basis, as has health care, but yesterday’s biggest sector losers were financials and industrials, two of the leaders of the 2013 rally. Added to that weakness is the lack of stocks making new 52 week highs, which was its lowest reading of 2013 yesterday:
This lack of leadership is telling. As this correction unfolds, watch for signs of new emerging leadership. For now, it’s a very small – and still contracting – list.