Friday, October 15, 2010

Financials Aren't Participating in the Rally

From the WSJ:

During the third quarter that just ended, the Standard & Poor's 500-stock index posted a gain of 10.7%, but it didn't get much help from some of the country's biggest banks. The Keefe, Bruyette & Woods Bank Index—which tracks 24 bank stocks, with the four heaviest weightings for Citigroup, J.P. Morgan Chase, Bank of America and Wells Fargo—was little changed.

Bank of America tumbled 8.8% and Wells Fargo slipped 1.9%. Citigroup, J.P. Morgan Chase and Morgan Stanley saw their shares gain modestly, by between about 4% and 6%, clipped by uncertainty over new rules from U.S. and global banking regulators.

Financials, taken more broadly, have also been the worst performing sector on the S&P 500 since that index reached its 2010 peak on April 23.

From the WSJ:

The mortgage-foreclosure crisis spilled into the financial markets on Thursday, driving down bank stocks and weighing on mortgage bonds as investors took a grim view of the potential costs.

Shares of U.S. banks fell, while the broader stock market was essentially flat. Bank of America Corp., potentially among the most affected, dropped more than 5%. Bank bonds also fell, and the cost of buying protection against a possible debt default by banks climbed.

"The level of uncertainty in the economy is at extraordinarily high levels to begin with," said Jack Scott, chief investment officer at BlackHawk Capital Management, a Charlotte, N.C., money manager that owns mortgage securities. "The foreclosure problem adds another layer of acute uncertainty."

So far, the foreclosure crisis hasn't affected consumer mortgage rates, which remain near record lows. They are closely linked to rates on U.S. Treasurys, which have tumbled in recent months.

The crisis has been escalating for several weeks, as banks suspend foreclosures across the country, citing flaws they have uncovered, including faulty or missing documentation. Tales of mismanagement within the foreclosure process—including so-called robo-signers, who were paid to rubber stamp documents without properly reviewing them—are emerging daily.

According to S&P, financial stocks account for 15.7% of the S&P 500 average, meaning they are really important. Every weekend I run an ETF performance chart on The last three weeks, this area of the market has distinctly underperformed other areas of the market.

Here is a chart that compares the two sectors

Notice that last month, the SPYs (the yellow line) rallied while the XLFs (the orange line) stood still. The sectors that are driving the rally are basic materials, energy, consumer discretionary and industrial stocks: