Trader’s Narrative

One of the signs of the tech bubble was how Information Technology as a sector ballooned from less than 6% (in 1989) to 29.18% (in 1999) in relation to the S&P 500 capitalization. Turning that idea on its head, let’s take a look at the financial sector during the past few years as a ratio of the general market.

As a caveat, let me reiterate that bull and bear markets within the financial sector don’t correspond to the general market: Does a bull market need financial stocks leadership? While at first it may be counter-intuitive, the data backs up the conclusion as you can see from the link.

But nevertheless, following the weight of sectors within the total market capitalization can help us in getting oriented. So I looked at the Standard & Poor’s Financials sector which includes the following sub-sectors (and more):

• Banks
• Consumer Finance
• Diversified Financial Services
• Real Estate Investment Trusts
• Insurance Brokers
• Life & Health Insurance
• Multi-line Insurance
• Property & Casualty Insurance

Here is the annual weight of the financial sector and the banking sub-sector relative to the S&P 500 capitalization (the charts below are interactive so mouse over for details). I was surprised to see that the financial sector topped out in 2006 at a whopping 22.27% of the total value of the S&P 500 index. That’s almost 3 times what it was in 1990:

Zooming in, we can see the monthly weight of the financial sector as a percentage of the total S&P 500 index capitalization from the start of the most recent bear market:

At the extreme low, set in early March 2009 just as the rest of the market was making its recent low, the financial sector reached a critical level it hadn’t seen since 1990! Since then it has jumped to 12.6% as the financial sector has lead the recovery in the general stock market. While no one knows if this is the definitive bottom for the banks, we can say that the March lows were a major low where the sector was as unloved as it has been for the past 20 years.

Free Access to EWI
The exclusive and limited time offer of a FREE 120 page report from Elliott Wave International is only valid for a few more hours. It is a mini-book covering the US, European and Asian markets as well as interest rates, commodities, currencies and much more. You’ll download the most recent edition of their comprehensive Global Market Perspective which exactly what their regular paying clients receive (except they pay $199 and you’re getting it free).

But it is only available free for a little bit more. You don’t have to purchase anything. I’ll go over it shortly on the blog so download your copy right now because this is your last chance.

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):

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:

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.