Financials Spook the Market

01/19/2009 11:40 am EST

Focus: ETFS

Jim Farrish

Founder and CIO, Jim's Notes

Jim Farrish, editor of SectorExchange.com, sees some new sectors exerting leadership as the market struggles to advance.

Last week, the technical conditions of the market went from rally mode to just trying to hold support. The negative sentiment picked up as the CBOE Volatility Index (VIX) spiked back near 56 last week. 

So, what changed? It all started with Congress and the proposed distribution of the second half of the Troubled Asset Relief Fund (TARP). That rippled into the financial stocks, which were dealing with rumors from Citigroup (NYSE: C) and Bank of America (NYSE: BAC). Those rumors were validated as the two banks did need more money from TARP and the Treasury. Throw in some bad earnings data and you have the making of a broad market sell-off led by the financial sector.

So, it was no surprise who the "biggest loser" was this past week: Financials won that dubious distinction, falling 13.4% and testing the November low of 165.81 in the Dow Jones US Financial Index. The DJ US Bank Index did establish a new low at 145.85, falling 23%.

Financials are a critical part of the US economy, and this turn of events could hamper attempts at a modest recovery in 2009. The allocation of $23 billion to Bank of America from TARP, and the US Treasury’s decision to guarantee another $400 billion plus in assets from Bank of America and Citigroup aren’t very encouraging. Fear is creeping back into the sector, and that could hurt the broad markets. It is important to see how this plays out short term.   

Scanning across the ten major sectors of the Standard & Poor’s 500 index, you get a mixed picture. Using Select Sector SPDRs for simplicity, the winners are Health Care (NYSEArca: XLV), Basic Materials (NYSEArca: XLB), Technology (NYSEArca: XLK) and Energy (NYSEArca: XLE) by the numbers.

But the leadership and positive outlook has been in Health Care, Basic Materials, and Technology. Energy has been very volatile and has been in effect more of a drag than a leader for the broad market. If these three sectors continue to provide the needed leadership, the potential is good for a bounce off support at 815 for the S&P 500. In my view, getting to neutral in the financial sector is the key to any move higher or holding support.

What to look for this week? The first priority is to hold support at 815 on the S&P 500 index. A move higher in the three leading sectors of health care, basic materials, and technology to create positive sentiment also would be helpful. I’d like to see the financials move to neutral and avoid additional market-moving news. Plus, there must be less saber rattling from the likes of Rep. Barney Frank and Congress. Some positive earnings news also wouldn’t hurt. And last but not least, it would be nice to see some stability in the energy sector.

The table below shows last week’s moves in the ten S&P 500 sectors. Some opportunities appear to be developing if we get through this current down swing and gather some upward momentum.

Jim Farrish, founder and editor of Melbourne, Florida-based SectorExchange.com, writes regularly about sectors and speaks widely about investing and money management.

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