Underperforming Banks: A Bad Sign for the Markets?

The Financial sector led us into the market meltdown of the past couple of years. Since the market bottomed in March, however, Financial shares have led us higher. So what is this important sector, specifically the Banks, telling us now?

Let's take a look at the performance of the diversified S&P 500 Index (SPX) (SPY) versus the long-standing KBW Bank Index (BKX). In the first chart below, you can see that the BKX has basically doubled the gain of the SPX since the March 9th market bottom.

SPX vs BKX Performance Chart since March Bottom

However, this outperformance trend appears to have shifted over the past month -- examine the next chart. Since October 14th, the BKX has lost about 13% of its value, while the SPX is down only 2.5% in that time frame.

Given the importance of the Financial sector, especially Banks, to the economic health and recovery of the U.S., this divergence looks to be a possible ominous sign for future broad market performance. Many have long considered Financial stocks to be a leading indicator for the markets.

SPX vs BKX Performance Chart since October 14

What comprises the BKX Index? Following is the holdings as of 11/04/09, source here. The top 5 holdings, each over 7% of the Index, are Bank of America (BAC), Citigroup (C), JP Morgan (JPM), US Bancorp (USB), and Wells Fargo (WFC).

BKX Holdings

Bottom Line: I would view this current underperformance by Banks to be a serious warning sign should it continue and/or accelerate. It may be indicating that there are further legs to drop in the global financial recovery.

Disclosure: No current Bank sector or stock position or client recommendation.

Comments

[Jasper M:]

A "mean reversion-ist" might argue that, since finance was so over-emphasized prior to 2007, this is just an internal correction.

However, I think the author is on to something. The graphs bear out reality - saturation: Debt mongers have no more prudent places to lend.

Nov 05 11:56 PM

[Gary A:]

I personally believe that we have many similarities to Japan. We subsidize the banks like they do. We are starting to spend less, like they do. We are avoiding formation of families, like they do.

Are we going to be like Japan? It is quite possible.

Nov 06 03:43 AM