Worry About Weakness in the Financial Sector

| About: Goldman Sachs (GS)

While the popular market indexes like the S&P 500 and the Dow Jones Industrial continue to climb, the banking sector continues to be mired in weakness. This important sector is often considered to be crucial for the bulls.

But right now, it continues to tread water and relative to the S&P 500 index, it is performing poorly - as it has for the past several years. The last time I considered this concept, I looked at the relative strength of the banking sector and concluded that there was no relationship between it and the S&P 500.

Bull and bear markets came and went with no real connection to the relative strength of the banking sector. But looking at this again recently, I’m not so sure. Instead of the relative strength, I decided to compare the previous behavior of the Philadelphia Banking Sector index (BKX) with what it is doing now.

Banking index 2007 top

The Banking Index was trading very weakly. In contrast to the S&P 500 index, it wasn’t able to reach new highs for the year in the summer. Instead, it traded lower. That provided a “death cross”, as you can see from the above chart, in mid-July 2007. This was months ahead of the eventual top for the S&P 500 index in October 2007. The “death cross” for the wider market arrived later, towards the end of the year.

Turning to the recent chart, we can see a “death cross” taking place in mid-August, as the financial sector fell along with the rest of the market in the summer selloff:

banking index death cross Oct 2010

Not only is the technical formation of a “death cross” a negative development for the sector, the following months only served to confirm this. Its limp reaction to the rally most other stocks have enjoyed is worrisome. As well, stalwarts like Goldman Sachs (NYSE:GS) are showing similar weakness, having closed at $154.73, well below their April 2010 highs of $184.

I’m not suggesting that we are headed down for a similar waterfall decline, like the kind that we saw in 2008. But it is a bit disconcerting to see the banking sector refuse to participate in this, otherwise wildly popular rally.

Checking in with Breadth
Meanwhile the general market continues to ramp up pushing breadth even higher. The percentage of stocks in the Nasdaq 100 index trading above their 50 day moving average is now 94%. The components of the S&P 500 index similarly trading is 93%. I don’t pretend that the market can’t move higher still but with so many cautionary lights flashing, it is improbable that this is the setting for a major and lasting move.

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