Is the XLF Sending a Signal?

The financial sector has failed to keep up with the broader market's rally off the mid-March lows, and that means something has to give, according to Carter Worth, Oppenheimer Asset Management's chief technician.

"This exact same circumstance manifested itself six months ago this week, with the market trading very well in late October and the Financials not participating at all," he wrote in a note today. The disconnect in October was resolved by a catch-up rally by the financials.

The S&P 500 has rebounded sharply since the roughly 6 percent correction in February and March and was trading Tuesday at a near three-year high. The XLF financial sector ETF was up about a half percent at midday, while the S&P 500 was up nearly a percent. The XLF is up 1.8 percent since March 16, and the S&P 500 is up 7 percent in the same period.

Worth says in his note that he believes the disconnect between the S&P and the financials will be resolved just as it was in October.

His reasons:

  • A good number of individual financial stocks are acting well (credit card companies, certain insurers)
  • The XLF chart is constructive, having sold off to a level of support (150-day moving average)
  • Many individual financial stocks have also reached support

and finally,

  • "Nobody NOBODY wants to talk about playing financials in any meetings I go to."

Some of the names he likes are on a list of stocks that have been the worst performers in the group and he says they are "so bad, that they're good."

Here's are a few: Bank of America , Goldman Sachs , Morgan Stanley , Wells Fargo , Keycorp , and U.S. Bancorp .
Of course, there's another side to this story. Glen Schorr of Nomura wrote on Tuesday that investors are worried about downward GDP revisions, uncertain regulatory environment, and macro risks, like the Middle East and European sovereign debt. All of those are keeping financial stocks down.

He notes that there's some normal seasonal slowing in debt underwriting and trading, and volatility has declined across several asset classes. The second quarter, he notes, is off to a sluggish start, but on the positive side, asset prices are holding up, merger activity and equity underwriting are doing fine, and there are positive inflows into bond and stock funds.

But Schorr, overall, sees some attractive upside, and pointed to Goldman Sachs, J.P. Morgan and Citigroup, all of which he rates buy.

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