Do Regional Banks Need to Sell Off Further?

• Posted by Greg Harmon
• on August 29th, 2013

Since the June 24 bounce began the S&P ($SPY) rose nearly 7.8%, the Financial Select Sector SPDR ($XLF) peaked up 9.1% and the KBW Regional Bank ETF ($KRE) maxed out at up about 12.8%. All are pulling back now with the S&P 500 and XLF leading the way down. They have given back 61.8% and a little over 78.6% of the moves higher. But the Regional Bank ETF is holding up much better, still holding over 50% of its gains. This begs the question of whether the Regional banks need to correct further before the entire banking sector can reverse?

The answer is no, but it is not so simple. Take a look at a long term performance chart of the Regional Banking Index against the Financial Select Sector SPDR below. This chart starts at the peak of the market for financials before the crisis began. You can see that in the beginning, Regionals sold off at about the same rate as all Financials (and in fact akll stocks) as crisis drove the market correlation towards 1. But since the first bounce in mid 2008 they have outperformed. This makes logical sense as the Regionals are smaller, more nimble banks than the XLF. In fact the top 10 components of the XLF comprise 44% of the ETF and include the likes of JP Morgan, Wells Fargo and Bank of America. The number 11 holding PNC Finanical at a 1.61% weighting as of 8/23/13 is the first bank that appears in the Regional index, and it only carries a 1.75% weighting there. The Regional Index should outperform. This would imply that Regionals do not need to

pullback further relative to broad Financials at least. Moving the comparison to the S&P 500 shows that Regionals have under-performed the broad market for the entire move off of the 2009 lows. They are only just starting to catch up and close the gap in 2013. So the out-performance in the first chart has a lot to do with the 4 years of under performance. I do not have an answer for you to the question above. Market movements can be fickle. But history supports the position that the Regionals do not need to pullback further to allow Financials as a whole to move back higher. Perhaps instead they will be the workhorses pulling up the rest of the Financials.

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