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Does A Bull Market Need Financial Stocks’ Leadership? at Trader’s Narrative

The financial stocks are not doing too well right now. I’m just telling you in case you’ve been hiding under a rock or have been floating in sensory deprivation tank for the last whee bit.

It seems everyone is looking at the poor financials and noting how weak they are relative to the market. The shibboleth is then trotted out that we need the financial stocks for a healthy bull market. I’m sure you’ve heard or read this multiple times.

I caught myself repeating it in my previous post (see above link). But rather than accept it at face value, lets put it to the test.

Does a bull market truly need the leadership or participation of the financial sector?

To begin, here is the chart of the Philadelphia Banking Index (BKX) compared to the S&P 500 Index (SPX):
ratio financial sector BKX to SPX long term chart

Remember, this is a relative chart. When the financial sector is doing better than the general stock market, the line trends up, and when they are weaker than the general market, the line goes down. And while the ratio showed incredible volatility between 1998 - 2003, the BKX was relatively unchanged, simply treading water the whole time.

Now lets see how the market actually behaved during the times that the financial stocks were leading and during the times that they were weak:

SPX long term chart bull bear markets

The bull market didn’t start in 1995 but it certainly did intensify with a sharp upturn in its slope. While the S&P 500 continued to rally - with intermittent corrections - until 2000, the Philadelphia Banking Index (BKX) only kept up its leadership till early 1998.

From then to the S&P 500 market top (otherwise referred to as the “bubble top”) financial stocks actually performed weaker than the general market. It certainly didn’t faze the bull market though.

Bull or Bear, Banks Don’t Care
As the tone changed and a bear market took hold, the financial stocks re-awakened and took leadership once again. They actually performed better than the S&P 500 as the bear market raged on. In retrospect, they were a decent hiding place. You didn’t make much money on an absolute level but you didn’t lose money either. If you had borrowed a tactic from a hedge fund playbook, I suppose you could have made money going long financial and short the S&P 500.

Finally, as the bear market subsided and a new bull market was born, the financial sector lost its luster and started to underperform again. Little at first but more recently, at a torrid pace.

I know this is a short slice of market history but even from such cursory analysis it seems that there isn’t much stock in the common belief that financial stocks need to lead a rally. Nor that they need to perform better than the general market for us to enjoy a bull market. In fact, there is no real relationship that I can discern. If you see one, please edumacate me.

I believe there are conditions that precede bull markets - this just isn’t one of them.

Sacred cows make the best burgers and this one is of kobe proportions. If your blood-lust is not satiated, let the intellectual slaughter continue by checking out how cumulative breadth can be misleading.

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9 Responses to “Does A Bull Market Need Financial Stocks’ Leadership?”  

  1. 1 JH

    Good observation.

    Perhaps we don’t need banks. However, the miserable performance may be telling us that banks aren’t going to be able to lend us out of our current malaise for a while.

  2. 2 Bruce

    On Australian share markets where resource stocks are the “big fish”, financials come second in the pecking order. Currently, miners and oils exceed the capitalization of the banks… They usually lead the market here…. Probably likely to for many years to come given the growing economies…


  3. 3 b.

    I think there is a difference between leadership (which is not needed) and a clearly ailing financial sector. While I agree that financials do not need to lead the way, they have to rise or at least side trade for the market to be able to start a sustainable bull rise. If you look through all the years you provided, a bull leg never started with the banks clearly falling on an absolute basis.

    Also, I think looking only at the banks index is misleading. While the 1995-2000 was not led by the banks, it saw *massive* gains for the brokers section of the financial system. Therefore, I think a more comprehensive view of the financial sector health/strength is needed to come to any firm conclusions.

    Best –

  4. 4 C

    well, it would certainly help the overall market if one of the largest components were in bull mode…I mean, come on — it is 20% after all. This isn’t telecom we are talking about…

  5. 5 Barry Ritholtz

    Very interesting

    But I am less sure the ratio (which i also use) is conclusive —

    What you are demonstrating is that other sectors can lead also:

    98-99-00 saw technology lead, so banks lagged
    same with 04-08 — energy and materials beat financials

    The key question is, what is the next sector to lead?

  6. 6 Babak

    yes, exactly - the point I was trying to make is that putting the financials under a microscope is a red herring

  1. 1 Wednesday links: financial sector woes « Abnormal Returns
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