They have been one of the leaders in the market since March, but some of them are looking tired…

Cracks Forming In Financial-Sector Stocks

By Joey Fundora

The financial sector has been in the spotlight for the past two years as one of the groups that led the way lower, and then recently, as the group that has helped stabilize the markets. This group has been intimately tied to the health of the overall markets, and it would be extremely difficult for the markets to have any traction without confidence in the sector. Recently, the financials have been rallying sharply after experiencing a gut-wrenching decline from October through March. Many of these stocks are at a critical juncture after clearing bottoming patterns and turning their intermediate trends higher. They are now testing some resistance levels while showing hints of slowing momentum. How they react to these levels will have important repercussions for the markets.

The chart for the Financial Select Sector SPDR ETF (NYSE:XLF) is revealing a critical test of the declining 200-day moving average. Notice how this average has contained the recent rally in check, as XLF consolidates the prior run up. It appears to be backing away from the average, and the persistent negative divergence in the MACD indicator is revealing a group that may be tired. While XLF is extended and at a resistance level, traders should not ignore the recent strength in the trend.  The 50-day moving average is trending higher, and XLF should find support on a pullback to this average.

Source: StockCharts.com

Goldman Sachs Group, Inc. (NYSE:GS) has maintained its role as a leader in the group over the past few months. Its share price has been steadily rising since clearing resistance in February. It has had only minor pullbacks, using the 20-day moving average as support for the past four months (shown by green arrows). While GS has continued its persistent uptrend over the past few months, there are signs of the advance slowing. GS is showing a negative divergence in the MACD histogram (new price high, not confirmed by a similar high in the indicator), which hints at waning momentum. Volume has also been declining throughout the entire rally.

Source: StockCharts.com

Wells Fargo & Company (NYSE:WFC) is another financial stock that has been acting well over the past few months. It cleared a choppy bottoming pattern in April and surged higher a few weeks later after a quick consolidation. WFC has been trading in a very tight range over the past two months, and has been holding above the 200-day moving average. The pattern is taking on the form of a larger cup and handle base, and the price structure still looks healthy. However, WFC is also showing divergences in the MACD indicator. This is fairly common after a stock has risen sharply in a short time frame, and simply acts as a warning that the rally may be getting exhausted. (For further reading, see What does it mean to use technical divergence in trading?)

Source: StockCharts.com

Bank of America Corporation (NYSE:BAC) is also showing a negative MACD divergence. BAC is another stock that has risen sharply from its February/March lows, and while the recent consolidation looks healthy, it’s possible that it needs more time to build a solid base. BAC has risen almost 600% from the low price of $2.52, and BAC could easily pull back to the $8 breakout area and still look healthy on a longer time frame.

Source: StockCharts.com

Bottom Line
The financial stocks above have been leading their sector over the past few months, and are some of the most widely followed by traders. This group has been in a persistent uptrend over that time, but it is still too early to determine whether this group is simply experiencing a temporary retracement of the bear market decline, or if these stocks have formed important bottoms.

The current price structure is still healthy. Prices are above rising intermediate time frame moving averages, and over recent bases. However, all of these are showing waning momentum and may be in need of a pullback or consolidation. Prices could easily continue higher, as this group is still heavily shorted. Divergences should not be traded without price confirmation, but it is too early to bet heavily one way or the other. One thing is quite certain: whichever direction the financials take next will almost surely be followed by the rest of the market.

Do you think the next move is higher for the financials? Will they have a sideways consolidation? Or do you think these stocks are headed much lower? Let us know by participating in the Investopedia Simulator.