One of the key questions heading into 2010 is whether or not the S&P 500 can continue to rally without participation from the Financial sector. The chart below highlights the relative strength of Financials and Technology versus the S&P 500 in 2009. In the chart, a rising line indicates the sector is outperforming the S&P 500, while a falling line is indicative of underperformance. Although it was the best performing sector off the bottom in March, the Financials have been underperforming the overall market since the start of Q4 '09, while other sectors like Technology have taken the lead.
Given that many investors are now of the view that equity rallies are led by the Financial sector, their recent underperformance has caused many to ask whether or not the equity rally will collapse under the weight of the sector. While renewed strength in this sector would be welcome to bulls, it isn't critical. To highlight this, we revisit the experience of the Technology sector coming out of the prior bear market in 2002/2003.
Back then, Technology stocks were the Financials of today after the sector declined 80% following a multi-year bull run. When the market bottomed in late 2002, Tech stocks led the initial surge off the lows. As the rally progressed, however, Tech stocks lost their leadership, causing skeptics to argue that their underperformance was an indication that the rally was running out of steam. In fact, during the last bull market leading up to the 2007 peak, Technology stocks underperformed the S&P 500 from the beginning of 2004 through the Summer of 2006. During that period, investors who were waiting on tech lost out, while other sectors like Energy and Materials stepped in to fill the void.
Instead of pre-occupying themselves with a specific sector of the market as the barometer for the overall market, investors should continue to focus on broader market measures such as breadth, volume, credit conditions, earnings, etc. as their guide.