Financials Flirt With Disaster on a Relative Basis

It's been well documented by now that Financials, the most important sector in the United States Stock Market, has been the worst performer since the end of last summer. Year-to-date, only the Consumer Cyclicals have managed to do worse than Financials. Unfortunately for the US Stock Market, I have to put Consumer Cyclicals in a similar category as Financials in terms of their importance. But today I just want to focus on the weakness we're seeing from the banks.

Below is a daily chart of the Financial Sector ETF $XLF relative to the S&P500. Here we're looking at a line chart since the relative lows 2 years ago. After peaking last summer, Financials have struggled hard and are now flirting with very important support. Not only has this been a key level of demand since the beginning of last year, but it also represents the 38.2% Fibonacci retracement from the entire 2012-2013 move:

With regards to Financials as a group, this would be a devastating break for the space. But the implications for the rest of the US Stock Market are even worse. This is supposed to be the leader in a bull market, not the laggard.

So what's the likelihood that we break? At this point it's anyone's guess, so I would prefer to err on the side of the underlying trend. To do this I like to lean on the direction of the moving averages. Here is the same chart shown above, but this time with the 50 (blue) and 200 (red) day simple moving averages overlaid:

For now, this market is still guilty until proven innocent. It's the worst perfomer out there since last summer, we're flirting with incredibly important support levels, and the trend is clearly down. From where we sit today, I find it hard to imagine a scenario where this doesn't break. I've been bearish about this space for a while, especially with how much the permabulls love it. When I put out a bearish note on Bank of America earlier this year, I got a ton of hate mail. We saw a nice 20% decline in shares of $BAC and structurally it looks like lower prices are still coming.

This is a terrible sector that has a lot of work to do in order to reverse course and turn bullish. I see this is as the lower probability scenario, and continue to lean bearish. If we do indeed break this key support on a relative basis, it will be very difficult for things to improve any time soon. Whether you're positioned in financials or not, I believe this one is still worth watching. In all likelihood, this resolution will have major market implications.

Look out below.

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Tags: $XLF $KRE $SPY $BAC