"Don't judge a book by its cover." We've all heard
that. The basic message is that one must look beyond
just the surface to discover truth. This
is especially good advice when looking at
sector exchange-traded funds (
ETFs
).
The financial sector has outperformed the broader S&P 500
since the June 2012 lows, up 14% versus an S&P's gain of
8%. But there certainly is more than meets the eye when it
comes to the financial sector's performance.
The Large Financial Sector
As of the September quarter end, the Financial Select Sector
SPDR (NYSEARCA:XLF) makes up over 15% of the S&P 500 by market
weight. It's the second largest sector by market cap,
behind Technology at 19%. A summary of those sector
weightings is best captured in the chart from Standard & Poors
(NYSEARCA:SPY) below.
Most investors are aware of the immense size of Apple
(NASDAQGS:AAPL) in the Technology sector with 24% of the sector's
weighting. But many are not aware that there are similar
dynamics occurring in the financial sector, albeit the domination
is not by one single company, but by an elite few.
Financial Sector Weightings
The S&P 500's financial sector as of 11/3/12 is made up of
82 financial companies and weighted based on market cap (stock
price x shares outstanding). However, just the top 10
financial companies out of the entire 82 make up a full 50% of the
XLF's market cap.
Furthermore, 5 stocks constitute 36% and just 3 stocks make up
over 25% of the XLF's value. Similar to Apple's dominant
position in Technology, investors can follow just 3 key financial
companies to help decipher the fate of the financial sector
indices.
The spreadsheet captures the breakdown of the financial sector
by market cap weighting including the top 10 companies in the
index.
The Key to the Financial Sector
The chart below shows the top 5 index constituents along with
XLF and shows the vast difference in performance in financial
companies. Since the June lows, 3 of the top 5 companies in
the sector, making up 20% of its weighting, have far outpaced the
other financial companies, up over 25% each and lifting the index
(in purple) over the past few months. Citigroup (
C
) in black, Bank of America (
BAC
) in red, and JPMorgan (
JPM
) in green have led the XLF significantly higher over the past few
months.
The more traditional banks such as Wells Fargo (
WFC
), and financial conglomerates such as Berkshire (NYSE:BRK-B) have
dragged the index down, underperforming their index by 5 percentage
points+.
An investor can follow these three financial companies to get a
better handle on where the broader financial index and thus markets
are headed.
Why the Financials Matter
In articles written on
8/17
and
9/26
we showed how the Financial and Energy (NYSEARCA:XLE) sectors were
the key to the market's continued rally. We also alerted our
subscribers on 7/21In our August newsletter how these sectors led
the market higher and lower over the past two months and how they
would also lead to the downside. "Their underperformance and
breakdown in early May helped identify the market's change in trend
from up to down and we are expecting a similar event at the
market's next juncture. Until these sectors break down, the
market's top likely is not in place."
After 4 months, these sectors continue to lead the markets
higher, barely; the financials with the help of its top 5
holdings. Once these large financial companies break down
from their impressive strength since June, we expect XLF
and thereafter the broader markets to confirm that a
near-term top is in place.
The
ETF
Profit Strategy Newsletter
uses relative strength analysis along with common sense technical
analysis to provide a short, mid, and long-term forecast along with
actionable buy/sell recommendations. This helps us
identify key trend changes in the sectors as well as the broader
markets.
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ETFguide