Financial Stocks Whisper a Warning for the Market
Vital Signs
IN THE LATE-SUMMER LANGUOR, the market delivers its message in a whisper. With the broad stock gauges almost exactly where they started the week, the market might seem to be speaking of stability and resilience -- the attributes that have allowed stocks to hover near the top of their long-standing range in defiance of some predictions of August angst.
With the most economically sensitive industrial stocks and the computer-chip makers (the basic-materials segment of the wired economy) surging, plenty of ears will gather that the market is echoing the economy's shift from canter to gallop, prodded by Alan Greenspan's riding crop.
It doesn't make sense to turn a deaf ear to these encouraging signs, given the market's impressive ability, so far, to digest the potent springtime rally without any scary downside purges.
But last week these upbeat noises couldn't quite drown out the market's murmured warnings coming from financial stocks, which underwent steady and determined selling all week, action that began to raise alarm among stock watchers by Friday.
The Dow Jones Industrial Average shuffled higher by 27 points to 9348, at one point reaching a 14-month high, helped by cyclicals such as Caterpillar and by Intel's happy report Friday that business this quarter is ahead of plan. The Nasdaq, a keener reflection of semiconductor strength, tacked on 63 points, or nearly 4%, to reach 1765. The Standard & Poor's 500 Index, after making another foray above the stubborn 1000 level, finished at 993, up less than three points for the week.
The straggling pace of the S&P 500 has an awful lot to do with the softening financial stocks, particularly banks and mortgage lenders. Banks as a group fell 2%, despite a generally steady bond market, although investors are continuing to question whether all banks have successfully weathered the ferocious rise in market interest rates and the tumult in the mortgage-backed securities market of the last couple of months.
Very little specific news hit these stocks, although Freddie Mac's chief executive, as rumored, did step down after the close Friday due to the inquiry into Freddie's accounting. Still, Bank of America -- a huge institution closely linked to the mortgage and consumer-loan markets -- dropped 3.8% on the week to 78.38, with most of the decline coming Friday on heavy volume. Citigroup, the largest financial name, also sank 4%.
With financial stocks comprising 21% of the S&P, it's hard for the rest of the market to overcome their weakness. More salient than their sheer heft is the reality that financials, the intermediaries of the economy and the market, must participate in if not lead any market advance in order for it to be sustainable. The history of enduring bull moves with the financials lagging is thin.
The backers of financial stocks have pointed out that the spread between short- and long-term rates remains rather wide, giving banks plenty of profit opportunity, and the important corporate-bond market remains firm.
True enough, but last week indicated that not everyone is so sure. Whatever the motivation for the selling, it probably means the broad market could have a tough time taking advantage of recently improved economic sentiment to forge another up leg. Last week, unemployment claims dipped again, leading economic indicators rose and the Philadelphia Fed's manufacturing survey sprang higher. This lent resolve to those buying deep cyclical stocks, but wasn't reflected in the top-line indexes.
John Roque, technical strategist at Natexis Bleichroeder, says that with Citigroup sagging and financials generally weaker, investors shouldn't feel there's much need to hurry into buying at this point. The idea of "upside risk" -- of being left behind by the market -- has animated professional investor behavior this year, as seen by brisk buying at the lower reaches of the recent trading range. That risk, seemingly, is diminished for the moment.
If all this activity ends up being is simple rotation of investors' funds from one group that has held up well for a long time into other areas more poised to prosper now, it will go down as a healthy process. The trouble is that rotation out of a sector that represents 21% of the large-cap market, and an even higher percentage of corporate profits, isn't conducive to market-wide upside. |
