A Leading Indicator Of a Higher Market

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Jan. 25, 2012, 12:01 a.m. EST

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By Mark Hulbert, MarketWatch

CHAPEL HILL, N.C. (MarketWatch) "” Financials as a leading stock market indicator?

It's easy to see why this notion has gained renewed popularity in recent sessions: Since the October lows, the Financial Select Sector SPDR /quotes/zigman/246222/quotes/nls/xlf XLF -0.14%  has gained nearly 30%, handily outpacing the 20% gain for the S&P 500 index /quotes/zigman/3870025 SPX -0.10%   itself. If that sector is a leading market indicator, then the market definitely has good things in store.

/quotes/zigman/246222/quotes/nls/xlf XLF 14.17, -0.02, -0.14%

Unfortunately, the historical record provides questionable support for this notion.

I base this sobering assessment on research conducted by Ned Davis Research, the quantitative research firm. The firm looked at how the major sectors performed, relative to each other, in each bull market since the early 1970s, four decades ago"”a total of 11, according to the firm.

While financials were the top performing sector in two of those 11 bull markets, they were below-average performers in six of them. Their average rank across all 11 bull markets? Fifth, out of ten"”right in the middle.

Nor is there any overwhelming correlation in the data between the magnitude of the financials' performance and the return of the overall market. In fact, there are two other sectors whose returns have been more highly correlated with the overall market than the financials"”industrials and consumer discretionary.

Click to Play $(function () { $("#video_F5935ED5-8B4B-4743-9FE7-B1EFD9553139").click(function (e) { e.preventDefault(); MarketWatch.Video.loadAndStartVideo('F5935ED5-8B4B-4743-9FE7-B1EFD9553139', 'video_F5935ED5-8B4B-4743-9FE7-B1EFD9553139', '287', '162'); }); }); Rally in bank stocks Is not a buy sign

Financial stocks, which led the rally back from March 2009, are surging. Although many look at bank stocks as a market barometer, leaders in past rallies don't spearhead the next upturn.

On both counts, it certainly doesn't look promising that the financials sector bears any special relationship to the overall market.

But there's more.

In turns out, according to the Ned Davis data, that since the early 1970s no sector finished in first place for two successive bull markets. Furthermore, there were many instances in which a sector that led one bull market was one of the worst-performing sectors in the next.

Given that the financials sector was the best performer in the bull market that lasted from March 2009 until April of last year, this does not bode well for the sector.

This analysis doesn't mean the financials must be a below-average performer over the next market cycle.

But don't fall into the trap of those who argue that the financials have to lead the market higher because banks in this sector are the veritable lifeblood of the economy.

The same argument was made following prior bull markets, when it was other sectors"”energy, for example"”that were at the head of the market's hit parade and it seemed "obvious" that they would continue to be so.

Click here to learn more about the Hulbert Financial Digest.

/quotes/zigman/246222/quotes/nls/xlf Add XLF to portfolio XLF Select Sector SPDR-Financial $ 14.17 -0.02 -0.14% Volume: 65.50M Jan. 24, 2012 4:00p var embeddedchart1488405048Chart = new EmbeddedChart('#embeddedchart1488405048', NormalChartStyleNoDecimals, 240, 80, '1dy', '5mi', null, null, null, 'US:XLF'); jQuery.data($('#embeddedchart1488405048').get(0), 'embeddedchart', embeddedchart1488405048Chart); /quotes/zigman/3870025 Add SPX to portfolio SPX S&P 500 Index 1,314.65 -1.35 -0.10% Volume: 584.74M Jan. 24, 2012 4:32p var embeddedchart124732823Chart = new EmbeddedChart('#embeddedchart124732823', NormalChartStyleNoDecimals, 240, 80, '1dy', '5mi', null, null, null, 'US:SPX'); jQuery.data($('#embeddedchart124732823').get(0), 'embeddedchart', embeddedchart124732823Chart); //$(document).ready(function() { var storywidth = $('#mainstory').width(); var maxwidth = storywidth; $('#maincontent pre').each(function (index, value) { var thiswidth = $(value).width(); if (thiswidth > maxwidth) maxwidth = thiswidth; }); var offset = maxwidth - storywidth; if (offset > 0) { var margin = 13; var blanketwidth = $('#blanket').width(); var contentwidth = $('#maincontent').width(); $('#blanket').width(blanketwidth + offset + margin); $('#maincontent').width(contentwidth + offset + margin); $('#mainstory').width(storywidth + offset + margin); } //});

Mark Hulbert is the founder of Hulbert Financial Digest in Annandale, Va. He has been tracking the advice of more than 160 financial newsletters since 1980.

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Mark Hulbert is editor of the Hulbert Financial Digest, which since 1980 has been tracking the performance of hundreds of investment advisors. The HFD... Expand

Mark Hulbert is editor of the Hulbert Financial Digest, which since 1980 has been tracking the performance of hundreds of investment advisors. The HFD became a service of MarketWatch in April 2002. In addition to being a Senior Columnist for MarketWatch, Hulbert writes a monthly column for Barron's.com and a column on investment strategies for the Journal of the American Association of Individual Investors. A frequent guest on television and radio shows, you may have seen Hulbert on CNBC, Wall Street Week, or ABC's World News This Morning. Most recently, Dow Jones and MarketWatch launched a new weekly newsletter based on Hulbert's research, entitled Hulbert on Markets: What's Working Now. Collapse

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