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Will the Volcker Rule Take Down Financial Stocks?

Chad Karnes

The final Volcker Rule isn't the "Volcker Rule," according to Paul Volcker himself, but he is happy with its balance between rules and principles.

The latest response by regulators to tighten their grip on Wall Street was completed this week, and the 71 page rule book along with 850 pages of legalese has finally been put into law. 

But does it really matter to financial stocks and their share prices?

The Reality of the Situation

Dodd Frank was enacted in July of 2010 with a backdrop of negative sentiment for financial stocks. But it had a surprisingly positive effect on the banks share prices, so should the latest Volcker Rule be any different?  The Dodd Frank Act helped mark the stock market's lows for 2010 when the S&P 500 traded as low as $1011, offering up a wonderful buying opportunity for financial shares such as JP Morgan (JPM - News).

A rising tide lifts all boats the saying goes, and financials have, like the rest of the stock market in 2013, responded to all news, good or bad, by rising. According to Bloomberg, the 2013 rally is the broadest on record as 447 of the 500 S&P stocks have risen.

Onerous rules or not, the market (thus far) doesn't really care about any of these regulations.  As a result, relying on the ever changing regulatory environment to help you decipher the market's next moves likely won't help much.

This is why we utilize technical and sentiment analysis alongside fundamentals to try to stay on the correct side of the markets.  So what exactly are the charts saying?

What the Tape Shows

Something happened in August 2013 that has not occurred since financial stocks kicked off their admirable rally from June 2012.  Financial stocks started to underperform the S&P 500.

The chart below was provided for subscribers in our September ETF Profit Strategy Newsletter and commented on the potential breakdown of the financial sector.  A few days later Financials indeed broke down confirming they were no longer the leaders of the market (SPY - News).

This means portfolio managers have likely been pressured to shift out of financial stocks and into other, better performing sectors, driving financial share prices down even further.  This indeed seems to be the case as the chart below is updated through today and the larger section of the chart shows the financial sector's underperformance continues through today.

In fact, only Utilities (XLU - News) have underperformed the market by more since they both broke down this summer.

As discussed in our September ETF Newsletter, if XLF and one other very important sector both breakdown together, it will be something that hasn't occurred since the rally from 2009 started and will be a warning sign that the market (VTI - News) is shifting out of its leaders and becoming more defensive.  This shift from leaders to defensive often accompanies major market turning points.

Although financials are already underperforming the broader market, thus far it hasn't meant an outright decline in their share prices.  And until joined by this one other sector, the longer term price uptrends will likely remain intact.  Luckily, we have the tools to warn us when these changes in the market occur.

For now underweighting financials (XLF - News) and staying long the broader market (IVV - News) is one way to take advantage of a lagging financial sector.  Aggressively shorting financials isn't the right call yet, however, the relative weakness of financials compared to the broader market suggests that time is likely approaching.

A breakdown in XLF's technicals will suggest a decline in financial stock prices is underway and a clear opportunity for bears. On the other hand, if you are expecting the latest Vocker Rule to rattle financial stocks, like what occurred when Dodd Frank was passed, waiting for confirmation first is a better way to play a market with a tide that is lifting all boats.

The ETF Profit Strategy Newsletter and Technical Forecast follow the major ETF asset classes and sectors in search of high probability profit opportunities like the one setting up in the financials.  We use fundamental, technical, and sentiment analysis to stay ahead of the major market trends with updates to our subscribers when those opportunities occur.

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