Why Technology And Financials Support Bullish Outlook

Includes: DIA, SPY, XLF, XLK
by: Financial Sense

Market Breadth Remains Strong in Technology and Financials

The financial and technology sector have a significant influence on the major indexes given their sizable weight, ranging from as low as 27.9% in the Dow Jones to as high as 60.8% in the NASDAQ (see table below). For this reason, keeping a close eye on their technical health can help shed some light as to the market's overall trend and health.

financials technology weightings
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As highlighted in Wednesday's article, "Market's Weekly Bill of Health," strong advances that are not in danger of putting in a major top are associated with broad-based participation with the majority of stocks heading higher. Conversely, an impending top is associated with weak breadth in which most stocks have stopped rising and have begun to roll over. One method for analyzing breadth highlighted in Wednesday's article is looking at the percentage of stocks above or below their 200 day moving averages (200d MA) and also the direction of the 200d MA. Based on these two criteria, it is possible to identify four corresponding categories of accelerating or decelerating trends shown below.

200d ma average evaluation
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When looking at the financial sector and technology sector we see broad-based strength with financials showing the strongest breadth and technology coming in fourth when looking at the percentage of stocks within the group in uptrends (defined as AR + AF). Looking at the table provided, 96% of the financial sector's members are in uptrends with the insurance and real estate industry subgroups showing the strongest breadth-100% of their constituents are in uptrends.

Moving on to the technology sector we see a healthy 86% of their members in uptrends and only 14% in downtrends (defined as BR + BF). The strong breadth in both of these sectors in addition to the overall strong breadth in the market (82% of the S&P 500 stocks are in uptrends), shows current momentum is very strong.

200d ma table
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Relative Strength Shows No Red Flags

In addition to looking at breadth for clues as to the health for the technology and financial sector, their relative strength to the overall market is also useful to monitor as these early leading sectors often peak prior to the market. This can be seen in the image below which shows the S&P 500 on top and the technology sector relative to the S&P 500 in the middle panel and the financial sector relative to the S&P 500 at bottom.

Notice, in the 2010 and 2011 corrections that occurred mid-year (two red shaded regions), in both circumstances the relative performance of the technology and financial sectors to the S&P 500 declined as these cyclical sectors provided early warning signs of a coming slowdown in the economy and corporate earnings. Looking at the present situation we see a different picture in which both sectors are outperforming the markets and confirming the price and strength of the S&P 500.

relative strength
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Source: Bloomberg


When looking at these two sectors' breadth in terms of member percentages above or below their 200d MA and the direction of their 200d MA we see that both are displaying impressive breadth that is stronger than the overall market. This leads us to conclude that the present market has healthy upward momentum and there are no clear warning signs of a market top. Technology and financials are currently overbought, as is the general market, and we are likely to experience a pullback or consolidation in Q2. However, given the level of internal strength, it does not appear the market is setting up for any major declines. Therefore, until we start to see broad-based deterioration in the market (and especially in these two sectors), any weakness into Q2 should be viewed as a buying opportunity.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.