Have the Financials Found Their Bottom?

Includes: XLF, XLY
by: Bill Luby

Halfway through Wednesday’s session, my screen is once again filled with red. The indices look as if they are poised to take a run at yesterday’s lows.

From a sector perspective, the picture is considerably muddier, as two recent laggards, financials (NYSEARCA:XLF) and consumer discretionary (NYSEARCA:XLY), are clinging to positive territory as I type this. As I see it, one or the other of these sectors will have to continue to deteriorate if the markets are going to continue lower from current levels.

Given that the financials are already down 53% from their May 2007 highs (see chart below), it is important to keep in mind that the easy money has already been made on the short side. A wide variety of financial sub-sectors (mortgage companies, bond insurers, money center banks, regional banks, investment banks/brokers, etc.) have already made multiple trips to the woodshed – and while some individual issues may still be quite vulnerable going forward, there is a limit to the amount of blood that can be squeezed from a broad-based ETF or index.

Going forward, I suspect the risk/return profile of the financial sector may actually favor the bulls. If the next couple of broad market moves down fail to pull the financials with them, the path of least resistance for the likes of XLF may indeed be up. Keep an eye on this development, because if (and admittedly this is a very large “if”) the financials are done falling, then the markets are likely to be ready to put in a bottom too.

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