Let’s look at a bit of history to see how correlated the health of the US banking sector is to the health of the broader market. We’ll compare the SPX (red line) to the Dow Bank index.
At the bottom of the chart below is a correlation study. It’s a valuable tool to help determine just how relative the movement of one security or sector is to that of another. In that pane, you will notice a split through the middle – that’s the “0” line. If the correlation line remains over the “0” line, it means there is a positive relationship between the security examined (Dow Banking sector) and the other market (S&P 500). If the correlation line falls –it’s a sign that the relationship is diverging negatively. If it drops below “0”—it’s an outright negative correlation.
You will notice that the correlation line is clearly positive most of the time. Obviously, this chart tells us that US banks tend move in sync with the broader market (SPX). On occasion, they are not in sync. At times like that, we can see that the banks tend to lead into a change in direction for the S&P 500. That move may or may not be a significant one. I’ve notated on the chart each time, since 2000, that the banks gave us a heads up to a change in direction for the SPX. They were:
- US banks rallied during the latter part of the 2001 of the technology crash (2001-2). They flagged the beginning of the bull market that did not begin for the SPX until 2003.
- In 2006, the banking index made a lower high in the last couple of months of that year, while the SPX made higher highs. Shortly after that occurrence we saw the 2007 market top and subsequent bear market for the SPX.
- The lower high by the banks in early 2011 vs. the higher highs on the SPX gave us several months heads up to the 22% correction on the S&P 500.
- Here and now: the banks are, without question, diverging negatively against the SPX. Is this a leading indicator for an imminent decline by the broader US market?
No one indicator will give you the insight that you need to know exactly how to position yourself for a market move. The banking sectors negative movement may prove to be significant. We may be getting a head-up here for a negative move on the SPX. Its been a pretty reliable indicator for the past 20 years (and beyond)–But it’s not a sure thing. As I have noted in this and other blogs…there are mixed messages on the market right now. Some are bullish, some not. As such, we are cautious.. For securities we do buy lately, they are undervalued stocks and ETF’s that appear to have dropped, based, and/or broken out. That, and range bound securities nearing the bottom of their trading ranges.
We’re being patient. We hold over 20% cash at this time, and have specific buy targets on about 10 different securities with alerts on our stock monitoring system should they reach our buy-prices.
By holding some cash and only buying a very select group of securities, we believe we are positioned as well as we can be for a potential correction – or a continuation of the rally.