LAST WEEK, THE DOW Jones Industrial Average finally broke out of a month-long pattern to set a fresh new high above the March high. Since other major market indexes had done that weeks earlier, the Dow's lack of confirmation had ruffled a few feathers among technical analysts (see Getting Technical: The Markets' Mood, "Still Waiting For the Dow," April 30).
After all, how could we have a true rally without confirming breakouts? And can one index rally while another falls?
Ultimately, though, only major changes are important, not these minor wiggles. The major change happened March 12, when the market as a whole made a 180-degree turn and began to rally. (The Dow did not make a new rally high largely because its most heavily weighted component -- 3M -- fell apart in April. But 3M remains in a rising trend from last summer.)
Sector-rotation buffs like to watch the financial sector, and banks in particular, for true signs of a new bull market. From a fundamental perspective, when the economy begins to recover, companies need to invest in equipment and inventory.
From a technical perspective, we have a precedent for the banks to be leaders during the early stages of the business cycle, which eventually gives way to leadership by technology, industrial and then raw-materials stocks. New bull markets need the banks to be among the leaders, and based on last week's action, that may be the case.
Or is it? A key benchmark of the banking sector is the Keefe, Bruyette & Woods bank index (BKX) traded on the Philadelphia Stock Exchange (see Chart 1). Last week, it vaulted over a key resistance level to its highest level since last July, suggesting that banks are back in favor.
But as most chart watchers know, nothing moves in a straight line for very long, and the BKX has been doing that since the start of April--arguably, even since the March 12 reversal bottom. If emotions are getting too strong and sentiment too bullish, prices will trade like this and can easily overshoot levels where they are "supposed" to take a breather. In other words, they run through resistance levels.
The problem is that the technicals are not supporting the index, setting up the possibility of a false breakout. When emotions rule, swings up and down become exaggerated. And given that the broad market is still well within the major trading range in force since last July, buying this breakout would appear to entail more risk than is prudent for ordinary investors.
The technicals behind the BKX are the same as those behind any stock. While there is no volume reported on the index itself, the volume for the majority of component banking stocks has not been impressive. Rallies need volume to continue. Call it their fuelâand fuel for this rally is lacking.
The price momentum for bank stocks hasn't been much to write home about, either. That leaves us with unimpressive volume, sentiment and momentum, and if we consider that the traditionally slow season for stocks is upon us, there's nothing left in the technical toolbox to excite us about the sector.
The BKX, an index of bigger and more national/international companies, isn't the only banking game in town; there also is an index for regional banks. The Merrill Lynch HOLDrs regional banks trust (RKH) is a basket of regional bank stocks traded like a stock on the American Stock Exchange (see Chart 2). Since bottoming in March, it, too, has rallied, but unlike its bigger cousin, it has not yet come close to meeting its previous highs.
Another benchmark, the Nasdaq Financial 100, is an index of the largest financial stocks listed on the Nasdaq Composite index (see Chart 3). It includes banks, brokers, insurers and financial services providers, so it is more representative of the financial sector as a whole.
What is most interesting on this chart, aside from the index failing to reach its old highs, is that it has been underperforming the Standard & Poor's 500 since the March market bottom. Not shown on this chart is its comparable underperformance to the Nasdaq as a whole.
All of this throws cold water on the claim that the current bullish phase of the market is being led by the financials.
And that in turn casts doubt on the staying power of the general rally. That does not mean that both the broad market and the banks in particular won't regroup and power higher. It just means that both of these markets are beginning to look a bit tired.
