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January 12, 2011  Wed 8:33 AM CT

XLF: SEE CHART GET CHAIN FIND STRATEGIES

As we earnings season gets into full swing, a look at how sectors have contributed to the performance of the S&P 500 is in order.

Over the next few days I want to highlight key sectors in terms of relative performance, their weight in the index, and one or two key names that will be reporting from each. Today's installment examines the financials.

The chart below shows the S&P 500, in teal, and the Financial Select SPDR (XLF) exchange-traded fund, in magenta. The one-year chart uses a percentage basis scale for easier comparison. In September of last year the financial sector hit its lows, with a year-to-date performance of nearly -12 percent.

At a 16 percent weighting within the index, that sort of negative performance was a large drag on the index at a time when the sector and the S&P 500 moved very closely together. The serious relative underperformance of the financials, as it continued to react to the potential crisis in Europe and regulatory concerns back home, was enough to keep the broader index down on the year as well.

XLF

We can see how the peaks that followed the lows in the financials helped push the S&P a little higher as well. At the time the effect was negligible and the broader index was very slowly trending up, with most sectors on the positive side other than the financial names.

The SPX crossed above the zero line in October. The financials followed much later, showing a big initial peak above the zero line in early November. That move had a smaller ripple effect in the S&P as well, as we can see by the abrupt bump above the trend. It was not until the financials corrected and then crossed zero again at the start of December that the S&P and the financials began to co-move more closely.

This time frame is important because the S&P 500 was able to break out to fresh highs for the year only when the financial sector turned positive. It illustrates the trader adage that no rally is sustainable without the participation of the banks.

JP Morgan, the most heavily weighted name in the financial sector at 9 percent, will report earnings results on Friday. The stock is well below its 52-week peak of $48.20, set just before the broad market decline began in April last year.

If JPM can beat expectations and provide a strong outlook, it could help the financial sector close the gap between its performance and that of the S&P 500. That, in turn, would likely see the S&P itself move to new recent highs.

If there is a disappointment, however, it could be the deciding factor in a bearish turn. Not only is the stock heavily weighted within the sector, but it is also the leader for other banking stocks such as Well Fargo, Bank of America, and Citigroup, which together make up over a third of the sector's weight.

(Chart courtesy of tradeMONSTER)

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