Financials just gave up this year’s gains — and that could be a terrible sign

  • The financial sector just gave up all of its gains for the year and is now negative year to date.
  • Some strategists say its underperformance is sending the broader market a message about the economy's health.

The financial sector just gave up all of this year's gains, and some strategists say that's sending the broader market a message about the health of the economy.

The sector, composed of a range of financial services firms such as insurance companies and banks, was leading the market for part of the year to date and was up 9 percent as of the beginning of March.

The drop is a function of rates falling, along with ongoing concerns about global growth, said Oppenheimer head of technical analysis Ari Wald. The yield curve, which serves as a gauge of economic growth, has flattened on the year, and generally that does not bode well for the banks, which rely on healthy net interest margins.

Financials underperforming in a falling-interest-rate environment flashes a "lacking vote of confidence about economic growth," he wrote Wednesday in an email to CNBC. Signals from the bond market indicate a premium should rather be placed on U.S. growth sectors, Wald said, like technology.

The sector has dipped into the red year to date as the third-worst-performing sector (just ahead of the telecommunications and energy sectors).

May has been a particularly rough month for the group; the sector was the second-worst-performing sector for the month, beaten to the downside only by energy.

At this juncture, investors ought to "sit-and-wait" on the financials, said Max Wolff, market strategist at 55 Institutional. Investors in the space were betting on sure-fire economic growth, reflation around the world, deregulation, and interest rate and balance sheet normalization following the U.S. election, he wrote in an email to CNBC. But the "reflation trade" and the prospects for deregulation under the Trump administration are now less certain, he wrote.

What's more is the share prices of the financials appear to have "leap-frogged into aggressive space" in hopes of such promised economic growth and deregulation.

In a note to clients Thursday, Michael Block of Rhino Trading Partners acknowledged that the financials have not performed well relative to technology, which is leading the market. Block said tech stocks could indeed keep running, but likely not in the very near-term.

"The rotation into value and energy and financials hasn't happened and tech outperforms," he wrote.

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Previously, Santoli was a Senior Columnist at Yahoo Finance, where he wrote analysis and commentary on the stock market, corporate news and the economy. He also appeared on Yahoo Finance video programs, where he offered insights on the most important business stories of the day, and was a regular contributor to CNBC and other networks.

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