Why US banks may be signalling a troubled market

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.

7 Comments

  • Hi Keith do you look at the transport index, housing starts, manufacturing output along with inventory levels as a leading indicators that it could show a downtick or a uptick in the economy ?

    Marc in Gatineau

    Reply
    • I look at the Dow industrials vs transports–which is doing fine (in sync – no divergence)
      I do not look at housing starts or manufacturing data as these are a bit more fundamental analyst oriented. Jon Vialoux looks at these on equityclock.com

      Reply
  • Thanks Keith, yes I do also follow Jon he as a very good mentor his Dad.

    Cheers,

    Marc in Gatineau

    Reply
  • Very good analysis Keith, thank you,
    I would like to state how turned off I am with the regards to Powell (federal reserve). He came out last week stating no more rate hikes in 2019. How can the Federal Reserve come out in March, only 3 months into a new year, and state this. Powell is playing into the hands of the big wall street firms, who obviously control the federal reserve like their own puppet.
    The economy may turn up and Powell may need to raise rates, so that statement was very, very suspect.
    As the 10 year U.S bond continues to fall, so do the markets, financials are leading the way down in a big way over the last couple weeks, which is an omen as to a serious market correction.
    Love you blog, very insightful.

    Reply
    • Thanks Ray
      And it appears that BOC is equally incompetent with their forward looking policy–witness the rate raising and hawkish statements over a year ago, and now the dovishness.

      Reply
    • Banks usually fair a bit better in a rising rate environment–all things considered (not the only factor, but it counts..) – the fed is dovish now, whereas they were hawkish a year ago, – which may be contributing to their weakness. That may signal a worried Fed – and banks can be a leading indicator when things are about to change–per this blog
      If the Fed sees potential of a slowing economy–thats a bad thing for the market.
      I cant see how weak banks directly connect to Trump. But if there is something you have seen that would, feel free to reply–interested in hearing about it. sometimes Trump is blamed for things that perplex me.

      Reply

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