Financial Stocks: Nice Knowing You, Time to Move On
With a good-but-not-great earnings season mostly in the books for the biggest U.S. banks, the financial sector's run as market leadership may be approaching its end.
Outside of Citigroup, most of the big financial institutions were able to beat modest profit expectations, and their shares have benefited.
But a consensus is growing that with regulatory pressures coming to bear and earnings outlooks dimming, a sector rotation may be under way, sending financials to back in the pack.
Analysts have been pulling back their estimates for financials for the fourth-quarter earnings season, with expectation that other cyclical stocks, such as industrials, could be the new leadership on the Standard & Poor's 500. (Read More: Where Is Top-Line Growth for 2013?)
"The driver for financials is simply the sluggish trading environment and thus does not point to macro weakness nor a deceleration in the economy," Thomas J. Lee, chief equity strategist at JPMorgan, said in his weekly market analysis.
Improvements in global purchase manger's index readings signal to Lee that industrials and technology stocks could be ready for a breakout.
"As global PMIs move upwards, cyclical equity performance has generally followed," he said.
To be sure, financial stocks have performed well so far in the young 2013 stock market after roaring 28 percent higher and leading a 13 percent market gain. They've returned 4.4 percent and are the fourth best of the 10 S&P 500 sectors.
Bank stocks more broadly have been less impressive.
The KBW Bank Index has been mostly flat since the banks began reporting, with concerns mounting that companies will have to get more innovative to drive market performance.
KBW analyst Fred Cannon pointed out that decreasing the amount of shares available on the market will be critical to bank stock performance. (Read More: Street Stumbles in Stocks, Backs Away From Bonds)
"Share repurchases are a critical feature of capital management for most of these large institutions as their capital levels are strong and asset growth is weak," Cannon said in a note. "However, achieving net share reduction is difficult for many because of Fed restriction and because they are issuing significant numbers of shares as part of compensation."
Float, as it is called, indicates the numbers of shares available. A decrease in float is considered a positive sign for a stock based on supply-demand rules.
"Looking forward, capital management will be critical in a slow-growth, highly regulated, banking world, in our view, and the most successful banks will need to be reducing shares outstanding to achieve strong EPS growth," Cannon said.
The earnings outlook overall remains muted, with analysts continuing to issue negative revisions. Outlook changes for financials have been trending negative, led by banks and insurers, while the picture has been improving for industrials.
Another metric analysts sometimes examine for direction in banking stocks is risk of default.
Spreads in credit default swaps - essentially insurance policies against default - have been approaching lows not seen during the stock market's bull run higher. As a contrarian indicator, that could be setting up as a headwind for financials.
"If default risk begins to creep up again, a big double top could be in store for financial stocks, which would be a negative technical formation," said Paul Hickey at Bespoke Investment Group. "Either way, the next couple of days/weeks will be key for the direction of financial stocks over the next few months."