Jim Farrish's  Instablog

The economic indicators have been pointing lower over the last six weeks and with the move has come renewed concerns about growth looking forward. The projections for a second half rally are still the hope of many economist, but the realities are mounting against those projections. With reality comes selling in the equity markets and if the reality sparks fear we could get panic selling. All the more reason to focus our portfolio and look at what is taking place in the broad market as well as the major sectors.

Financial stocks have been struggling all year. The sector is down 4.3% year-to-date and 11.3% from the high in February. We have discussed the issues facing the broad markets since the attempt to move higher in May, but the financials have been in a methodical downtrend since hitting their high in February. The fundamental data continues to show weakness in both the balance sheet assets and willingness to increase lending. Banks have been very conservative in their approach to lending. In addition they have been under increased regulatory pressure as well as uncertainty to what new regulations will be adopted or passed by Congress. The witch hunt by politicians has not helped, nor has the public perception or opinion of banks. Bottom line, the sector is in trouble and the trend is accelerating to the downside.

Whether the current activity is driven by fear or a lack of willingness by the consumer to borrow or use credit, the facts are simple to see on the chart below of the Dow Jones US Financials Index. Bank stocks have underperformed the S&P 500 index and they are a catalyst currently on the downside. The chart reflects the recent selling acceleration in the downtrend and all support near term has been broken. Technically the sector is in trouble and has been for some time. Financials are acting as the catalyst to the downside for the broad markets. 270 is the support level for the index and it will be important short term relative to how far the sector falls.

The Treasury bond activity has shown an equal worry relative to the future as interest rates have declined and bonds have risen. The chart below of TLT, iShares 20+ Year Treasury Bond ETF shows the rise in bond prices. Taken in conjunction with the chart above you can see the worry in action by investors. Does this mean stocks are going to correct near term? Not necessarily, but it is a big warning sign for investors. Money is rotating away from risk/growth stocks and into gold, cash, bonds and other defensive sectors of the market. If the fear level rises you will see more money flow into bonds and cash. Watch to see how this plays out. Currently the VIX index is still low with no signs of panic selling.

The move below 1300 on the S&P 500 index is a big negative for the broad markets. Throw in the push lower in financials and flight to quality into bonds and you add another negative to the outlook. The pieces are falling together for a correction in the broad index, but for now we are looking at the 1250 ish level to hold support on the downside short term. If the fear factor grows disproportionately, we could go lower. For now we play the downside and watch how the investor reacts short term. Don’t get overly zealous about being short the market. Take it one day at a time and follow the trend.