Trader’s Narrative

The spring rally began in early March with the financial sector taking leadership and rising from a death spiral. The Philadelphia Banking Index (BKX) rallied with such a ferocity that in about two months time it had more than doubled.

In fact, by early May 2009, the financial sector had gone up by an astronomical 135%! Meanwhile, the wider market index, the S&P 500, had only managed a 35% increase. On its own, that was very impressive rally but it pales in comparison to the banks.

The banking sector is now 13.35% of the S&P 500 - it reached a low of 8.57% on March 6th (to see more historical data and graphs check out: Historical Weight of Financial Sector.)

But while the S&P 500 went on slightly higher in June, the financial sector as measured by the Philadelphia Banking Index (BKX) started to lag. This was the first time in many months that it didn’t move in lockstep with the general market.

So if the Banking Index (BKX) has given up leadership, which sector is driving the market higher?

Currently the Semiconductors (SOX) is going strong with Information Technology being the largest sector of the S&P 500 at 18.3%. As well, Transportation and Energy sectors continue to have relative strength. The question is, is this a normal sector rotation or does the weakness in the important financial sector mean that the market has lost an important leadership sector and will weaken as a result?

Santander’s takeover of Sovereign Bancorp is a great example of the smart money vs. the dumb money. Santander has had Sovereign in its sights for a long time and had been rebuffed by them. But Santander is now using this crisis as a catalyst to buy up the remainder of Sovereign it doesn’t already own.

Emilio Botín, the head of Santander, has banking in his blood. His family has had control of Santander for four generations. He took over a staid, lazy bank and took it to the top position in Spain. Not content with that, he then started to expand outward. He’s already 71 and after his retirement the family legacy is expected to continue with his daughter, Ana Patricia Botín taking over.

Santander is already one of the world’s largest banks and earlier this year Euromoney named it as the world’s best bank for 2008. It has operations in Europe, as well as in England and Latin America. This new acquisition brings Santander into the US.

Here is Botin schooling the rest of the banking world in his thick Spanish accent on the 3 important principles of banking - the video goes wonky towards the end but the sound is good, so listen up Wall St.!

Got that?

Keep in mind that the strongest banks in the world are in Canada (as a group).

Today’s market notwithstanding, the financial sector has started to lead the general market once again.

Here is a chart of the Philadelphia Banking Index (BKX) alongside the S&P 500 Index (SPX):

The de-coupling started just recently but it is unmistakeable. Here is another way of looking at the relationship between the indices:

The change has just started and it is far too early to declare a trend change just yet. For that, we need to see the downtrend line broken to the upside by a continued surge in the financial sector.

But the important thing is that counter intuitively, a bull market doesn’t need the financial stocks’ leadership.

Bullish Percent
The spike low corresponds to late June, when the bullish percent for the banking sector dipped below 10% - actually going all the way to 5.62%. The last time we saw the bullish percent this close to zero was back in mid January 2008. And as far as I have data, never before!

Tectonic Shifts
This financial turmoil is unprecedented. For as far as the Philadelphia Banking Index has been trading, it hasn’t broken down this drastically. What we are seeing is tectonic shifts in the banking industry which will not only reverberate for some time to come, but it will produce a horizon drastically different from the one we knew just a month ago.