Equity mutual funds recently saw their largest weekly inflows since 2000 and the CBOE Volatility Index has dropped to its lowest level in about five years. Sentiment is turning more bullish on the market and the S&P 500 is approaching its all-time high.
At this critical juncture, investors should keep a close eye on two sectors that are often leading indicators for the overall market: financial stocks and emerging markets. If they continue to show relative strength then it’s likely the S&P 500 will break out to new record levels. [Investors Bullish on Stock ETFs]
“The S&P 500 continues to probe the resistance zone drawn across from the 2012 highs,” says Tarquin Coe, technical analyst at Investors Intelligence.
ETFs for financials and the emerging markets offer clues as to general market direction, he wrote in a note.
“Both areas have provided leadership during the recent equity rally. Should these leaders weaken, then the rest of the market may follow suit,” Coe said.
Financial ETFs were standout performers last year, and a slew of big bank earnings this week could set the pace for the first quarter.
“So goes the banks so goes the broad market … it has worked that way for years, so keep this important sector in mind for the macro picture,” Kimble Charting Solutions said in a note last week.
“It’s a make or break week for the financial sector with five of six of the nation’s largest banks scheduled to report fourth-quarter earnings results,” Yahoo Finance reports. “Bank stocks have seen strong gains ahead of these key earnings reports … Earnings expectations for the group are relatively strong.”
These banks are among the top stock holdings in Financial Select Sector SDPR (XLF). The sector ETF is trying to break out to post-crisis highs for the third time at a key resistance level. [Financial ETF Near Four-Year High Eyes Breakout]
Like the S&P 500, Financial Select Sector SDPR is testing a major resistance ceiling, said Coe at Investors Intelligence. “Although the fund is at its highest level since October 2008, trading is yet to pull away decisively from resistance and that is a negative,” he wrote.
Emerging market ETFs
ETFs benchmarked to developing economies have outperformed the S&P 500 for several months. Related ETFs such as iShares MSCI Emerging Markets (EEM) and Vanguard FTSE Emerging Markets (VWO) have seen very strong inflows in early 2013. [Investors Flocking to Emerging Market ETFs Amid Rally]
Yet EEM has displayed several “gaps” higher recently that could mean the rally is getting tired, Coe points out.
Meanwhile, the relative chart versus the S&P 500 has started to break its uptrend of the past four months. “That implies underperformance is commencing and that will put the general market rally under threat,” the technical analyst said.
Financial Select Sector SPDR
iShares MSCI Emerging Markets
Full disclosure: Tom Lydon’s clients own EEM.
The opinions and forecasts expressed herein are solely those of John Spence, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.