The market may be near record highs but financials are now down for the year.
The S&P’s financial sector index now joins consumer discretionary in negative territory in 2014. Financials make up about 17 percent of the benchmark S&P 500 index.
Mark Newton, chief technical strategist at Greywolf Executions Partners, says the financials have been showing weakness since July, though its long-term uptrend remains intact based on the charts of the Financial Select SPDR ETF (XLF), which tracks the sector.
“We have seen a little bit of churning in the last few months but it's tough to really argue for broad-based weakness,” Newton said. “Within the group, there has been a lot of weakness within the regionals in particular. Those are getting down to levels which I think are important.”
Relative to the S&P 500, XLF appears to be setting up for a buying opportunity and a bounce over the next couple of months, particularly with regional banks, broker-dealers, and even some of the larger banks, said Newton.
“The XLF would actually need to get under an area near $21 initially and then $20.50 to think we're going to have a bigger correction overall in absolute terms,” Newton said. “For now, we haven't seen that.”
Kevin Caron, portfolio manager at Stifel Nicolaus’ Washington Crossing Advisors, says there’s a fundamental reason why financial institutions are taking on the chin this year: The spread between shorter- and longer-term interest rates—the slope of the yield curve—has gone down.
“There's a very strong connection between the performance of the banks and the shape of the yield curve,” Caron said. “The long end of the yield curve has been coming down for a variety of reasons.”
Those reasons include the Federal Reserve Bank’s tapering of its bond-buying monetary stimulus, a flight to safety due to concerns about Ukraine, as well as weak U.S., European and Chinese growth in the first quarter.
“All of those things [are] driving up Treasury prices, down the bond yield, [and] flattening the curve,” he said. “That has been a bit of a wet blanket on the expectations for profitability for banks. So, I’m not at all surprised to see that the financials have been lagging somewhat with all of those things taking place.”
To see the full discussion on the financial sector, with Newton on the technicals and Caron on the fundamentals, watch the above video.