Thursday, May 29, 2008

Do The Banks Need To Lead The Next Rally?

There is a school of thought that says the banks and financials got the stock market into this mess and they will likely need to lead the market out of it. The sectors that get beat up the most on the way down do tend to bounce the best off the bottom, and it would seem difficult for the market to kick off a strong bull phase without at least some participation from the banks. Expecting them to lead may be a bit much, though. Let’s take a historical look at the BKX vs. the SOX from a relative strength standpoint. I use the SOX here because of its reputation to lead.

The current ratio of the BKX to the SOX is about 0.18. On January 1st 1995 it was also about 0.18. It has traveled quite a bit to get nowhere. In early July of ’98 the ratio hit a high of close to 0.36 and in March of ’00 it hit a low of about 0.05.

In the chart below I show the S&P 500, the BKX and the SOX. At the bottom of the chart is an intermediate-term relative strength measure. It looks at the current ratio as opposed to the 20-week moving average. When the red line is above the blue, that means the BKX is outperforming the SOX. When the red line is below the blue, that means the SOX is outperforming the BKX.

Since the beginning of January 1995 the S&P 500 has gained about 924 points. (I did these calculations mid-day on Wednesday.) When the SOX has outperformed the BKX the S&P has gained 1264 points. When the BKX has outperformed the SOX, the S&P 500 has lost 340 points. The BKX has spent roughly 6 years and 2 months leading and 7 years and 3 months lagging.

What if we compare the BKX to the S&P 500? This may provide a better picture of leader/laggard without worrying about the SOX. The BKX/SPX ratio is about 0.054 now. In January 1995 it was 0.056. In this case the S&P has gained about 979 points when the BKX was a laggard, and lost 55 points when the BKX was a leader. Not quite as severe, but the point remains the same – historically the BKX has not been a leader of strong rallies. The market may have trouble rallying strongly without faith in the banks, but that doesn’t mean these classic laggards will all of a sudden become powerful leaders.


Anonymous said...

hate to say it but this time is different, without the banks credit wont expand and consumer will pull back too much, your quant models are missing what it is just common sense

Damian said...

And thus, another fundamental investor/trader (anonymous above) seems to not understand how models work or the nature of probabilities. Anonymous - Rob is not saying it is not different this time, he is simply pointing out historical relationships and that conventional wisdom is often not tested.

deke said...

mentioned the holy grail long for QQQQ a week ago(48.30), when daily chart adx is above 30 and touches the 20 day ema, goal of that trade is a test of the high(50.47), and since volume was heavy on the day of the high, a wyckoff trader would say 'the high will get a retest, no telling when'...AAPL GOOG RIMM all had the holy grail long setup as well, and those 3 alone have provided about 55% of Q's gain since march low