The stock market has continued to press higher this week and many sectors have been performing very well alongside the general indexes. However, not all sectors are participating, and in fact, one critical group is clearly lagging the markets. The financials have been weak over the past few weeks and are showing a clear divergence from the major indexes.
Notice that while the S&P 500 and Dow Jones Industrial Average are trading at new highs, the SPDR Select Financial Sector Fund (NYSE:XLF), which represents the financial sector, has not been able to muster up the strength to clear even its April highs. The chart doesn't look terrible overall, but the negative divergence is certainly worth noting.

Source: StockCharts.com

One of the reasons for this divergence is the underperformance in stocks like Morgan Stanley (NYSE:MS). MS looked great as recently as a few months ago when it cleared a base in early January. MS followed through and rallied up to the $31 level before a gap-down reversal. Typically, a stock will find support on the first pullback from new highs at its prior breakout area, and while MS did pause near $27, it eventually caved in. MS is now back under its 200-day moving average in stark contrast to the major indexes. (For more, see Playing The Gap.)

Source: StockCharts.com

Another stock that has been lagging is Goldman Sachs Group (NYSE:GS ). GS has been considered the leader in this group for several years, but it too is having a hard time making any progress. GS cleared the $155 level last October and appeared to have finally shaken off some of the weakness that dogged it for a large part of 2010. However, GS recently broke down under this level on a surge in volume. With an unfilled gap just above it, this level will be a key one to watch moving forward.

Source: StockCharts.com

Much like XLF, the chart for JP Morgan Chase & Co. (NYSE:JPM) doesn't look all that bad in a vacuum. JPM has held its breakout from earlier this year and has respected the $44 level on the last two pullbacks. However, when taken in context, JPM is also still off its highs at a time when a large portion of stocks are trading at new highs. (For more, see Support And Resistance Basics.)

Source: StockCharts.com

The Bottom Line
While there can certainly be a rally without participation from the banks, a truly healthy bull market will eventually need this group to tag along. The banks are an early cycle group and their health corresponds directly to an improving economy where money is being loaned to businesses. Until they get in gear, the markets will be in more of a recovery than a bull phase.

At the time of writing, Joey Fundora did not own shares in any of the companies mentioned in this article.

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