Financial ETFs Started Strong But Now Face Headwind

Includes: KBE, KRE, XLF
by: Wall Street Sector Selector

by John Nyaradi

The Financial sector represented by ETFs like Financial Select SPDR (NYSEARCA:XLF) has enjoyed rapid, recent gains, up nearly 15% since the mid-December lows four weeks ago. Regional banks have been strong as well, with the SPDR S&P 500 Regional Bank Index (NYSEARCA:KRE) up 13% over the last four weeks and SPDR KBW Bank Index (NYSEARCA:KBE) gaining 13.8% over the same time period.

Large banks like Bank of America (NYSE:BAC) have experienced significant gains, up approximately 20% since the start of 2012, and regional banks like SunTrust (NYSE:STI) have logged double digit gains year to date, as well.

Until Friday, the banking sector had become more optimistic in recent weeks as economic reports showed improvement in the United States and Europe appeared like perhaps it might not fall off a cliff. Federal Reserve support for the endangered housing industry has also added strength to the financial sector.

Since the onset of the financial crisis, banks have been battered by the European crisis, problems in the housing industry and ongoing high unemployment. These factors had been showing steady improvement until Friday’s downgrade of major countries including France, Austria, Italy and Spain generated daily losses for the sector.

However, overall the markets seemed relatively unfazed by such major news and on the positive side of the ledger, Italy had a strong bond auction and over the weekend, German Chancellor Merkel promised faster and more resolute action in response to the S&P downgrade.

On a technical basis, the financial sector has been strong with the index above its 50 day moving average and just at its 200 day average, while the regional index is above both the short and longer term lines and has recently formed a “golden cross," wherein the 50 day average has moved above the 200 day and this action is widely seen as a “buy” signal.

Major earnings reports from banks will be coming in over the next few weeks and a major European summit is scheduled for the end of the month. Goldman Sachs (NYSE:GS) is scheduled to report earnings next week while JP Morgan (NYSE:JPM) reported a 23% decline in profit last week but was up for the year and forecast better days ahead. CitiGroup (NYSE:C) and Wells Fargo (NYSE:WFC) report earnings on Tuesday, Goldman Sachs and U.S. Bankcorp will report on Wednesday, Bank of America reports on Thursday and SunTrust and Fifth Third Bancorp (NASDAQ:FITB) reports earnings on Friday.

Earnings are forecast to be strong, and with the financial sector being a predominant factor in the S&P 500, next week is important not only for the financial sector to continue its strong trend but also for the general health of the market going ahead, as well.

Bottom line: The general markets need the financial sector to participate and lead any rally for that rally to be self-sustaining. Earnings this week and developments in Europe will drive us into the future or over the cliff.

Disclosure: Wall Street Sector Selector actively trades a wide range of exchange traded funds (ETFs) and positions can change at any time.