Bank ETF Flashing Short-Term Bullish Signal

Longer term, XLF's rough March could mean more trouble

Senior Quantitative Analyst
Mar 22, 2023 at 8:53 AM
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Turmoil in the banking sector has made for an interesting month. It started with Silvergate Capital (SI) announcing it was shutting down operations earlier in the month, then the collapse of Silicon Valley Bank (SVB) really shook markets. The largest financial ETF is the Financial Select Sector SPDR Fund (XLF) and it’s down about 10% for the month and over 20% off its highs from early 2022. This week, I’m looking at historical XLF collapses to see how it performed going forward and how the broader stock market has performed during those times as well.

Short-Term Rally, Long-Term Headwinds

I found past instances that the XLF fell by at least 12% over a two-week period. There had to be at least three months since the last occurrence. This happened last Friday, in which the ETF was down about 14% over the prior two weeks. It’s a rare occasion with just nine prior signals since 1999, the first full year of XLF trading.

I listed all the dates this happened along with subsequent returns for the XLF. I also summarized the returns in the table and for all dates since 2001, the year of the first signal. The data is extremely interesting. After these signals, the XLF has performed very well over the next three months. It averaged a return of 6.8% with 78% of the returns positive. The typical three-month return for the ETF has been about 1% with 61% of returns positive. Furthermore, the standard deviation of the three month returns after a signal is about the same as the typical standard deviation.

The longer-term returns, however, are different. 12 months after these occurrences, the XLF averaged a loss of 3.5% with five of eight returns positive. The standard deviation of 12-month returns is much higher than normal with a couple of huge drops after these signals. The two big drops, however, were related to the financial collapse of 2008-2009. The other six times, the XLF gained double-digits five times and had one loss of 7% over the next 12 months.

So, it’s common after a significant collapse of the XLF to see very bullish returns over the next three months, but vulnerability to huge selloffs after that initial bullish phase. Perhaps it’s a plot that tends to play out in which the banking system falters and is then shored up by regulators (something that is happening now). The policies sometimes end up being a short-term fix for a bigger problem. Only time will tell. Since the financial crisis in 2008-2009, the XLF has done fine over the next year after falling 12% or more during a two-week stretch.

XLF Steep Drops

What Does This Mean for the SPX?

Lastly, I’m looking at how the broader stock market has tended to react to sudden drops in XLF. It’s the same analysis as above but looking at S&P 500 returns after those dates. The results follow the same pattern. The three-month return for the S&P 500 has averaged a gain of 5.7% with eight of nine returns positive. The typical three-month returns for the S&P 500 since 2001 is about 1.6% with 66% of the returns positive. The 12-month returns show five positive returns with four of them being over double-digits and three negative returns with all of them being by double-digits. Overall, the S&P 500 averaged a small loss over the next 12 months. But a median return of 9%. Based on this history, you could expect some bullish returns over the next few months but a lot of uncertainty after that.

SPX After XLF Drop


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