Bank Stocks' Recent Woes Could Be Contagious

A funny thing happened on the way to one of the greatest bull markets in history. The financial sector, whose miraculous recovery from near-death made it all possible, has lapsed into a coma.

At their highwater mark last week, stocks as measured by the S&P 500 were up 64.1% in 253 days, the best performance since 1933, only equaled two other times in the recorded history of U.S. stock prices. The financial sector has led the way, and has turned in an even more amazing performance. At the S&P 500 Financials sector's highwater mark, it was up 160% in just 222 days.

Now here's what worries me. For the last month, while stocks overall have moved on to new highs, the financial sector hasn't. In fact as of Nov. 24, it was off 6.7% from the highs it made in mid-October. Over the same period, stocks overall are up 1.2%.

The question is: from a technical standpoint, can stocks keep rising when the engine of growth that has powered this whole bull market has sputtered out? From a more fundamental standpoint, the question is: what's gone wrong in the financial sector, and does a problem here pose a threat to overall economic recovery?

The technical question can potentially be answered in an upbeat way. There's nothing wrong with a little sector rotation. In fact it's healthy to see different sectors take the lead at different points in a bull market. It's like a relay race in which one runner rests after passing the baton to the next runner.

The problem here is that this runner isn't just resting, he's moving backward. Financials have actually lost value since passing the baton a month ago.

How about the runner to whom the baton was passed? In some sense the baton was passed to all the other runners at once. There's no other sector that's down since the top for financials a month ago.

The three other sectors that have done the best since then -- doing about as well as financials did badly -- are telecommunications services, up 6.4%, health care, up 5.8%, and consumer staples, up 4.2%.

Bull markets are sustained by moves in sectors that have a compelling story behind then, a story that captures the imagination of investors and keeps them buying. Of the three that have done the best in the last month, only health care has a good story.

In my judgment, what's driving it is the increasing probability that the government takeover of health care now being rammed through Congress is going to not happen, or at least not happen much. I know it looks like an unstoppable freight train, with the congressional leadership using every trick in the book to get it done by hook or by crook. But I think the reality is that the legislative progress that's been made so far has only been by the narrowest of victories, and has been based on unsustainable compromises between interest groups. When it comes time for the full Congress to really vote on a single bill, I think the only way legislators will be able to agree on anything is by passing a watered-down bill that will have the effect of no bill at all. So health-care stocks are rallying on hopes that when all is said and done they can get back to business as usual.