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RELATIVE STRENGTH RETURNING TO FINANCIALS

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Happy New Year!!!!

It's been awhile since I've spoken about the financials in a positive light.  As sector rotation continues though, it appears as if the financials may get their turn after all.  I've been watching bank after bank, financial after financial, either moving to a fresh 52 week high or blowing past 50 day SMAs over the past couple weeks, this latest week especially.  JP Morgan (JPM), Bank of America (BAC) and Wells Fargo (WFC) are among the largest financials and have led the parade.  Volume on these stocks and other financials was on the rise as well, helping to confirm the move.  A strong financial group has been the one missing ingredient to what otherwise has been a very bullish move off the March 2008 lows.  During the first two months of the rally, financials were a relative leader.  Since then, however, they have languished.

I believe one of the most important factors in seeing higher equity prices in 2010 is a rebounding financial sector, relative to the S&P 500.  It needs to happen.  A healthy financial sector leads to credit for small business and opens up job opportunities for the unemployed.  Now that the monthly job losses have moved closer to the zero line, the next step to take equity prices higher is to actually begin to add jobs each month and lower the unemployment rate.  Again, this brings me back to the need for participation from a healthier financial sector.  Technical analysis is based on the premise that price action will precede fundamental changes.  Therefore, it stands to reason that before we'll see additional improvement from financials, we'll need to see technical improvement first.  Take a look at the chart below:

DJUSFN vs. S&P 500 1.9.10
The above chart really highlights two things.  First, notice that financials have yet to make their initial relative target of .265 based on their measurement from the bottoming head & shoulders pattern I've identified.  This is important because technical conditions are predicting relative outperformance from financials in the days and weeks ahead.  Take note that there has been relative weakness, not strength, from financials from mid-October through the end of 2009.  But as we look for a catalyst to take equity prices higher in 2010, financials may be emerging with relative strength at just the right time.  The relative strength line has turned higher in the first week of the year and I've provided a dotted line above to forecast what we might see over the next several weeks.

The second item of note in the chart above is the top portion of the chart, where I'm showing the performance of the bank index, relative to the Dow Jones US Financial Index.  That ratio has not only turned higher, but for the first time since the downtrend began in late 2008, I'm actually seeing higher highs and higher lows in this relative ratio.  So two things are occurring here - financials are beginning to show relative improvement vs. the overall market AND banks are outperforming within the financial space.

I'm expecting the financials to continue to perform well and, as a result, have scanned for banks within the space that appear solid technically.  We're featuring one of them, Webster Financial Corp (WBS) as our Chart of the Day for Monday.  Click Here to see an annotated chart on WBS and my video analysis.

Happy trading!

Tom Bowley
About the author: is the Chief Market Strategist of EarningsBeats.com, a company providing a research and educational platform for both investment professionals and individual investors. Tom writes a comprehensive Daily Market Report (DMR), providing guidance to EB.com members every day that the stock market is open. Tom has contributed technical expertise here at StockCharts.com since 2006 and has a fundamental background in public accounting as well, blending a unique skill set to approach the U.S. stock market. Learn More
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