Financial Stocks Scream for Caution

by Michael A. Gayed | October 25, 2013 6:00 am

Financial Stocks Scream for Caution

“Distrust and caution are the parents of security.” – Benjamin Franklin

As the S&P 500 surged to new highs on Tuesday after a disappointing payroll report (bad news is good news in the QE addiction era), a number of negative divergences were evident. Important among these was a lack of leadership in the cyclical groups, particularly Financials.

The ratio of Financials SPDR (XLF[1]) to the SPDR S&P 500 (SPY[2]) peaked back in July and has failed to confirm the new S&P highs reached in September and October (see bottom panel in the chart below). Over the past week, the ratio has moved sharply lower. As a reminder, a rising ratio means the numerator/XLF is outperforming (up more/down less) the denominator/SPY.

On an absolute price basis, the Financials sector could be in the process of forming a triple top pattern (see top panel in chart below). We need to see further weakness in price to confirm, but with relative strength leading to the downside, at the very least caution is warranted.

xlfspy102413 Financial Stocks Scream for Caution
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JPMorgan (JPM[3]), one of the most important components of the Financials sector, is also showing notable weakness here. Its price and relative strength both peaked back in July, failing to hit new highs with the S&P in September and October (see chart below). It is also potentially forming a head and shoulders topping pattern and a break below $50 will confirm this pattern.

jpm102413 Financial Stocks Scream for Caution
Click to Enlarge

It seems as if every month we hear about a new JP Morgan settlement, the most recent being a whopping $13 billion fine for engaging in misleading mortgage practices. Investors initially shrugged this news off but they may now be realizing that the once-bottomless well of litigation reserves is starting to run dry.

What does all this imply? Continue to keep a close eye on financial stocks for further signs of relative weakness. This is an important indicator as all of the major corrections in the S&P 500 over the past few years (17% in 2010, 21% in 2011, and 11% in 2012) were preceded with significant weakness in the Financials sector.

While the broad market can certainly continue higher without Financials being the top sector, you never want to see it near the bottom. We aren’t there yet and momentum in the broad equity indices remains strong, but that could change quickly if these topping patterns play out.

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

Endnotes:
  1. XLF: http://studio-5.financialcontent.com/investplace/quote?Symbol=XLF
  2. SPY: http://studio-5.financialcontent.com/investplace/quote?Symbol=SPY
  3. JPM: http://studio-5.financialcontent.com/investplace/quote?Symbol=JPM

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