March 20th, 2009

Financial Stocks are Laggards

As the market appeared to begin what I considered the bottoming process (see October 17, 2008), I inserted the following graph depicting the four phases of the market’s life cycle.

I also wrote:

“This phase [accumulation] occurs after the market has bottomed and the herd (corporate insiders, a few value investors, smart money managers and experienced traders) begins buying, guessing that the worst is over. Valuations are very attractive, general market sentiment is still bearish, the media preach doom and gloom and those who were long through the worst of the bear market have recently given up and sold the rest of their holdings in disgust (the “capitulation”).

In the accumulation phase, prices stay relatively flat and for every seller throwing in the towel, someone is there to pick it up at a healthy discount. Market sentiment is in the early stages of switching from negative to neutral. In the accumulation phase of the Market Life Cycle, few reliable chart patterns have developed, most stocks are far from making new highs (one of my favorite criteria for identifying upside momentum), traditional momentum scans offer few candidates and it is still too early for reliable relative strength filters (stocks movement relative to S&P 500).”

One source for early leaders is what I call “golden cross” stocks. Another category (many of which also fall into the “golden cross” category) are those rare stocks that do have compelling chart patterns. Over the past several days, I’ve list some stocks that are clearly in the process of forming typical and easily identifiable reversal patterns. I prefer a longer-term time horizon and seek stocks like these in the accumulation phase, stocks that will be the leaders and generate higher returns than the Indexes as the market moves through most of the next mark-up phase of its life cycle.

By contrast and for comparison, many financial stocks neatly fit instead into the category of “falling knives” and are nowhere near the beginning of any sort of reversal or consolidation patterns. In other words, if you’re a trader with a short-term time horizon, there may clearly be opportunities for large percentage profits accompanied with significantly higher risks. Contrast the sharp declines and equally sharp bounces of these financial charts (and these are merely a small sample of with similar charts) with the previously mentioned stocks with consolidation patterns :

  • C (Citicorp)
  • BAC (BankAmerica)
  • WFC (Wells Fargo)
  • GE (General Electric)

There have been huge percentage gains for those who had the courage to buy somewhere near those lows. Even though I believed each of these financials would survive (easy enough to say as a Monday-morning quarterback, I guess) , I didn’t have the “guts” to gamble my hard-earned and still safe cash for bets like these. As a chartist, I believe these stocks will soon reverse direction again and the inverse spikes (the falling knives) will morph into the leading edge of some sort of better defined bottom reversal patterns.

It’s often said that financial stocks are the in Industry Group that leads the market out of the average Bear Market. In this case, however, the financials not only lead us into the Bear Market but they were the principal cause. Comparing their charts against those shown earlier, the financials seem to be lagging by 4-6 months behind other industry groups. Their significant share of the US economy and the major market indexes could explain why individual stocks have started to move up several months before there’s any evidence of the Indexes having turned.

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