Do Financials Hold the Key to the Continued Uptrend?

Are financials in the drivers seat for the broad markets? They held up during the broad market melting lower on Wednesday. The reaction to the durable goods data sent the materials (XLB), industrial (XLI), energy (XLE), and utilities (XLU) sectors lower. The large cap financial sector (XLF) managed to squeak out a gain on the day. Breaking it down the banks held the sector up as they made solid gains. The brokers reacted to the Goldman Sachs news on reorganizing the executive suite to permit more corporate governance. Regardless the question remains, can financials lead the broad market higher?

Most analyst believe the banking sector is better today than it was one year ago. The number of analyst buy recommendations on the sector has increased slowly over the last year as well. The trend of the sector is higher and the indicators are all pointing higher. Does that translate into growth for the broad markets overall? The answer is only found in the actual results moving forward, but the belief or research leads us to invest in the sector with expectations of the stocks moving higher.

The chart below of XLF, SPDRs Select Financials ETF shows the acceleration of the uptrend following the test lower in December. The current move has pushed against resistance at the $16 level. The 30 day moving average and the trendline have set the support for the sector and would represent the short term stop level relative to the current move. The near term target is the March 2011 high of $17.20. Watch for some volatility to creep into the sector if the negative outlook similar to Wednesday’s news gains momentum from investors. The trend off the October low would be the longer term support to watch and if we should test that level be a place to add to or buy back into the sector.

Banks (KBE) have been the catalyst to the sector on the trend change and they continue to be a key to the advance. Brokers (IAI) have made¬†a solid move higher and added to the upside of late. The ETF has low volume, but filtering the holding to find the leaders has turned up JP Morgan (JPM),¬†Ameriprise (AMP), Jefferies Group (JEF), Raymond James (RJF) and TD AmeriTrade (AMTD) leading the way for the sub-sector. Insurance (KIE) and regional banks (KRE) have done equally well on the upside. For now we expect the trend to continue higher as the fundamental data has begun to confirm the improvement in the sector. This doesn’t mean the sector will move straight up. I would expect volatility along the way, but the opportunity is in play with upside remaining for the sector.

What about sell in May and go away? We are ending the March period and the rumors are starting to rumble. Will we get a pullback, sell off, correction? Who really knows? Why do we fret so much over things we cannot control? The chart below is the S&P 500 index. The trend of the October low remains in play. The trend higher has accelerated to match the 30 day moving average. Thus, the first level of support is the trendline and moving average. The second level is the original trendline near the 1340 level currently. That corresponds with the February four day pullback test. The key is to not over think what is happening or may happen. Define your potential risk relative to the time frame you are looking at or investing for. Set you stops accordingly and keep moving forward. As investors we have to understand and accept that we will never pick the bottom, nor will we pick the absolute top. Thus, be willing to capture the part of the move that works for you and your portfolio. The question begs, do we sell in May and go away? Only if the trend of the market tells us to do so. Until them we stay and play in accordance with our discipline.

I added the weekly chart of the S&P 500 to give the bigger picture of where we are and what obstacle lie in front of the index technically. The original trendline off the March 2009 low is just overhead and could become a factor, but more importantly is the rising wedge pattern on the long term chart. These generally end on the downside or reverse the trend. They take time to resolve and break as we are looking at a weekly chart. The current pattern is six months in duration, but it is reaching the apex of the pattern. This trend is worthy of monitoring as we move forward. As with all analysis we are developing what we believe to be the opportunity, the reality is the right side of the chart going forward. Manage your risk and follow your discipline.