Investors should keep a close eye on Financial Select Sector SPDR (XLF) for any hints the rally is losing steam. Bank earnings kick off next week and some institutional investors have taken bearish bets against the financial ETF, which saw its biggest intraday reversal in over a month on Wednesday as volume jumped.
Some traders have been positioning for weakness in the banks with put options on XLF, according to Paul Weisbruch at ETF liquidity provider Street One Financial.
Short interest in XLF is currently running at 20.5%, according to XTF.com.
The financial sector ETF fell Wednesday after economic reports on ADP private-sector payrolls and ISM non-manufacturing came in weaker than expected. Bank stocks could see action Friday when markets get the March employment report.
"Despite rising 1Q estimates, given 1) sequentially slowing trends throughout the quarter, and 2) our view that 1Q beats will not be large enough to significantly raise investor views of long-term earnings power - we remain on the sidelines with most of these names," Citigroup analyst Keith Horowitz said in a report from TheStreet. "Given the stocks' recent runs, looking out over the next 12 months we believe higher valuations are more likely to be dependent on higher earnings power rather than a repeat of last year's large-scale multiple expansion."
Last month, the Federal Reserve said 17 of 18 banks passed its latest round of "stress tests."
Financial stocks were solid performers in 2012 and equity bulls are looking for more strength from the cyclical sector as the S&P 500 and Dow Jones Industrial Average test all-time highs. XLF gained about 28% last year to nearly double the return of the S&P 500.
Yet if the financial ETF starts to lag the market, it could be a warning sign for the bulls. "As go the piggies, so goes the poke," Minyanville founder and CEO Todd Harrison is fond of saying on the bank stocks.
Financial Select Sector SPDR