Sectors To Watch: Financials Hold The Key To The Markets Next Move
Did you know that financials are the best performing sector so far this year?
The Financial Select Sector SPDR (XLF) is up an eye-popping 22% this year. That’s an impressive run any way you slice it.
Financials are beating out strong performances from the tech stocks (up 19%) and consumer discretionary stocks (up 15%) for the top spot.
No doubt about it, it’s an amazing feat for the much maligned sector. And it’s a great sign that the current bull market still has room to run.
Simply put, financials must be moving higher if the bull market is going to continue.
But here’s a problem…
So far the rally in financials is due to the easing of capital concerns. Investors are bidding financial stocks up as the sovereign debt crisis in Europe cools off and all but a few US banks passed the Fed’s stress test.
In other words, things went from bad to less bad. And we almost always see a sector rally in that situation.
Now investors focus will shift to the financials ability to generate earnings.
Remember, financials are unique from other sectors. They interact with and are dependent upon the success of other sectors and industries. They also benefit the most when the entire economy is hitting on all cylinders.
Here’s the real kicker…
Right now, the US is closer to having the economy firing on all cylinders than it has been since before the housing bubble burst in 2006.
Just look at the recent economic data. Manufacturing, employment, consumer, and even housing data are all stronger than they were at this time last year. And at the same time inflationary pressures are cooling off. In fact, the latest round of economic data was the most positive data we’ve had at the same time in the last year.
Put simply, that’s a recipe for strong earnings and further gains in financial stocks.
Better yet, the data isn’t just getting better… It’s better than expectations. And when economic data is better than expectations, it tends to drive the market higher.
After taking a breather over the last week to consolidate its impressive gains, financials and the broad market are poised to move higher once again.
Look, even the strongest bull markets don’t go straight up. They pause… they pullback… and they have missteps along the way.
But the truth is stocks had become extremely overbought. And the last week’s price action is normal and healthy for a bull market.
One more thing… institutional funds are rebalancing their portfolios as the first quarter draws to a close. As you know, many funds must maintain a balance between stocks and bonds (like 60% stocks and 40% bonds).
And since stocks have dramatically outperformed bonds in the first quarter, these funds must sell stocks and buy bonds to regain their proper balance. The good news is any headwinds this rebalancing is creating should subside next week.
Here’s the bottom line…
I’m expecting to see the market and financials get back to their bullish ways next week.
One way to play it is buying calls on XLF. You can buy XLF May 2012 $16 Calls for about 33 cents.
Good Investing,
Corey Williams
Category: Sectors To Watch
