An overview of sector strength shows that 9 of 10 sectors increased in strength and finance stocks reached an overbought level. For this analysis, we are looking at the Bullish Percent Index (BPI) from StockCharts.com. This indicator is calculated by dividing the number of stocks in a given group that are currently trading with Point and Figure buy signals, by the total number of stocks in that group.

4/3/09

4/9/09

Finance

66.67

80.25

Info Tech

66.27

71.08

Consumer Discretionary

66.42

69.43

Materials

58.43

66.29

Energy

49.45

58.24

Industrial

46.67

56.67

Telecom

53.33

46.67

Healthcare

41.32

46.11

Consumer Staples

38.96

42.86

Utilities

16.90

16.90

Most technicians consider a level of 80% to represent an overbought extreme, indicating that the market may be ahead of itself. At the other end of the spectrum, levels below 20% are considered oversold and technicians expect to see a market bounce from this level. Before acting on this common wisdom, one is best served recalling that “markets can remain irrational longer than can you remain solvent,” a comment widely attributed to economist John Maynard Keynes.

Within the finance sector, bank stocks are up 75% on average since the March bottom (only five weeks ago). The market news this week was dominated by Wells Fargo (WFC) which reported better than expected earnings. The stock is now 155% higher than it was five weeks ago.

These types of gains are reminiscent of the blow-off top in internet stocks that occurred in the first months of 2000. Keynes would probably agree that the markets have been irrational in 2009. Either the 74% decline WFC suffered in the first part of the year or the recent gains are signs of a mania.

The fundamentals show that WFC is trading at 29 times earnings. Analysts expect the company to deliver respectable earnings gains of 9% a year over the next five years. Even if they are off by as much as they were last quarter, the stock is richly priced.

With the breadth of financials being overbought, and so much of the recent rally being a result of their strength, it seems certain that now is not the time for large commitments to that sector. The bigger question is whether or not any stock should be bought at this point, after such rapid gains.

We remain in a trading market and investors should consider potential risks to be just as great as potential rewards. Over the past week, the industrial and energy sectors showed the greatest strength, as measured by BPI. Leadership is likely to continue rotating on a weekly basis as the underlying trend of the market seeks to exert itself. Only time will tell if that is a bullish or bearish trend.