Financial Sector: A Bearish Signal

Chart 1: Financial sector is showing warning signs of a major top

In one of the recent posts, I showed how Health Care sector breadth divergence could be signalling that an uptrend might stall soon enough. Participation and leadership by various stocks is slowly dwindling to lower and lower numbers. The same is true for the Financial sector of the S&P 500. The chart above shows that the Financial sector bearish divergences are evident in the Summation Index, % of stocks above 200 MA and 52 week new highs.

Chart 2: Financial sector has been failing to push towards new highs!

So why is the Financial sector so important? I could do a whole write up about how banks are the arteries and credit creation is the blood of the economy, but I will spare you the thesis - I'm sure you can read plenty of them on all other blogs. The truth is, Financials (XLF) lead the rally out of the October 2011 low. Now, almost two years later, the sector has doubled in value, looks overbought and exhausted to move higher. Recently, it failed to confirm the new highs S&P 500 reached in September - sure warning sign.

Chart 3: Financial sector tends to anticipate a turn in major trend

During the major market top in October 2007, and even more recently in May 2011, Financial sector was the "tell-tell" by peaking months before the final high. This type of price action usually signals that not all is well within the stock market. Fast forward to todays price action and the chart above clearly shows Financial sector underperformance relative to the whole S&P 500 yet again. It is a false signal, just a correction or a major bear ahead? It remains to be seen... but please do not be surprised that it is happen again, after all we just continue to kick the can down the road in the US, Japan and Europe!