Chart of the Day: Main Risk for US Banks? European Banks

The European financial system has been the source of fears of contagion over the past three years. This time around, US financials are not concerned.

The euro crisis has reared its ugly head again, but this time around, the market is saying, “Not going to be fooled by the boy who cried wolf.” In the last three years, the market has hit its low for the year on the dramatic headlines and riot videos in Europe, only to eventually continue its bull market run. So riots and bank runs again? Traders refuse to be fooled this time.

In the US market, the financial sector has been the biggest beneficiary of this new outlook. To see what I mean, here’s a look at the chart of the European bank index (INDEXSTOXX:SX7E) vs. the US financials ETF (NYSEARCA:XLF)* over the last two years:

SX7E vs. XLF daily, Two-year chart, Courtesy of Bloomberg
Click to enlarge

*Note: XLF has some non-banks, but its correlation with the large corporate and inv. banks is close to 1

Over the past two years, the US financials have moved in the same broad trend as European financials, even if the magnitude of the moves were different (European banks sold off more and rallied less). I’ve shown with arrows the two major selloffs and two major rallies over the past two years.

But a major divergence has occurred since January 2013. That’s the “boy who cried wolf” divergence, as US market participants choose to ignore Europe in 2013, even as European banks have started to sell off on fears about the periphery once again. The European financial system has been the source of fears of contagion over the past three years. This time around, US financials are not concerned.

US financials have had one piece of good news after another to start 2013, and if you disregard the European stress, the sector seems poised for outperformance the entire year. But some wily traders like those at the Macro Man blog think, “This creates a more dangerous environment for markets as complacency levels with respect to Europe are at levels not seen since for some time.” Should be an interesting month ahead of us.

This item by Enis Taner was originally published on RiskReversal.com.

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