Wells Fargo and Bank of America up by seven percent

Led by Wells Fargo and Bank of America, financials were the worst performing sector in August with the Financial Select Sector SPDR (XLF) dropping more than 8 percent. A combination of concerns ranging from worsening home loans to reduced trading profits due to market inactivity were to blame for the steep losses.

That all changed this week as the sector came roaring back from a one-year low, with Wells Fargo and Bank of America up both by more than seven percent. Technical analysts were heartened by the swift bounce off support levels established in February and July, while fundamental investors were encouraged by attractive valuations and a better-than-expected jobs report today hinting at improving credit quality. These same market watchers feel the financials may be setting up for a short-term trade for the fall.

"Support at the February low was tested successfully before the XLFs gapped higher on Wednesday,” said Katie Stockton, chief market technician for MKM Partners, in a note. “We believe the gap is a ‘breakaway’ gap, which is usually found toward the beginning of moves."

Financials are key to the overall market’s success because despite the massive loss in value during the credit crisis, they still make up the second-largest portion of the S&P 500 at 16 percent. Before the crisis, it was the biggest. Technology is the largest slice of the pie now at 18 percent.

The bank stocks find themselves in a similar position as the stock market, trapped between a lockbox range established at the start of the summer. The sector faces stiff resistance, where many buyers will be looking to take quick profits, at about 4 percent from here for the Financial SPDR (XLF).

The group has a shot to breakout further as we approach the end of the quarter, according to Brad Hintz, analyst for Sanford Bernstein and former CFO of Lehman Brothers (well before the collapse).

"What we’re going to hear from the companies is that their reserves are fine, their loan portfolios are fine, and their investment portfolios are improving because of the rally in the bond market,” said Hintz.

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