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Will sudden relative weakness in Financials weigh on the market? (XLF, SPY) - September 29, 2010

|Includes: Financial Select Sector SPDR ETF (XLF)
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September 29, 2010

A tug-of-war between the bulls and bears was the dominant theme of yesterday's indecisive session, which concluded with the bulls having the upper hand. Getting off to a nervous start, the major indices were trading approximately 1% lower after the first 30 minutes of trading. However, buyers stepped in to lend support, enabling stocks to move back to the flat line by mid-day. Choppy trading ensued in the afternoon, but the main stock market indexes still closed solidly higher and near their intraday highs. The S&P 500 Index rose 0.5%. The Dow Jones Industrial Average and Nasdaq Composite registered matching gains of 0.4%. The small-cap Russell 2000 and S&P MidCap 400 indices jumped 1.0% and 0.8% respectively.

Although intraday price action may have started out a bit shaky, volume ticked higher across the board, confirming the gains of yesterday's session. Total volume in the NYSE was 12% greater than the previous day's level, while turnover in the Nasdaq rose 13%. The higher volume advance enabled both the S&P and Nasdaq to score a bullish "accumulation day," indicative of institutional buying. It was the sixth such occurrence this month. In the NYSE, advancing volume exceeded declining volume by a healthy margin of 3 to 1. However, the Nasdaq adv/dec volume ratio was only fractionally positive by little better than 1 to 1.

Last night, we took an updated look at the recent performance of 25 industry sectors, using "percentage change charts" that compare each index with the percentage change of the benchmark S&P 500 Index. Over the past two weeks, only a few industry sectors have been showing clear relative strength to the broad market by outperforming on the up days, and faring better than the major indices on the down days. Semiconductors, Retail, and Internet are three such industries (semiconductors only began perking up a few days ago). However, what really caught our attention was a laggard performance of Financials over the past week. To clearly show this, check out the chart below, which compares the relative performance of the S&P 500 SPDR (NYSEARCA:SPY) versus the Financial SPDR (NYSEARCA:XLF) over the past 10 days:

XLF

What's interesting about the chart above is that XLF did not begin showing bearish divergence and relative weakness to SPY until September 21. In the five days prior to that period, notice that XLF and SPY were trading in sync with one another, but XLF has suddenly become a laggard. This is also the case on the daily chart, as XLF still remains well below its August highs. We do not point out the relative weakness in XLF to suggest selling short the financial ETFs, as current sentiment favors the bulls and the long side of the market overall. Rather, we bring the relative weakness in Financials to your attention because the sector is so heavily weighted within the broad market. As such, unless XLF (as an ETF proxy for the overall financial sector) gets back in sync with SPY, we believe the relative weakness in the financial arena will begin weighing on the overall market rally very soon. In fact, the performance of the financial sector is commonly a leading, not lagging, indicator of broad market direction.

In yesterday's commentary, we illustrated that the S&P 500 (as a proxy for the broad market) is at a pivotal crossroads. Even though the S&P advanced on higher volume yesterday, the index still remains below last week's high. Therefore, nothing has really changed on an overall technical level. Nevertheless, yesterday's "accumulation day" was indeed bullish, and increases the possibility of the major indices moving higher from here. But based on the choppy intraday price action of the broad market yesterday, it is prudent to stay alert and not place any aggressive bets on the market while stocks are consolidating at key resistance levels.


The commentary above is an abbreviated version of our daily ETF trading newsletter, The Wagner Daily. Subscribers to the full version receive specific ETF trade setups with detailed trigger, stop, and target prices, as well as daily updates on all open positions. Intraday Trade Alerts are also sent via e-mail and/or text message, on as-needed basis. For your free 1-month trial to the full version of The Wagner Daily, or to learn about our other services, please visit morpheustrading.com.

Deron Wagner is the Founder and Head Portfolio Manager of Morpheus Trading Group, a capital management and trader education firm launched in 2001. Wagner is the author of the best-selling book, Trading ETFs: Gaining An Edge With Technical Analysis (Bloomberg Press, August 2008), and also appears in the popular DVD video, Sector Trading Strategies (Marketplace Books, June 2002). He is also co-author of both The Long-Term Day Trader (Career Press, April 2000) and The After-Hours Trader (McGraw Hill, August 2000). Past television appearances include CNBC, ABC, and Yahoo! FinanceVision. Wagner is a frequent guest speaker at various trading and financial conferences around the world, and can be reached by sending e-mail to: deron@morpheustrading.com.




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