Bank stocks should be scooped up after declines, according to the charts

The Financials Select Sector SPDR Fund (XLF) has gained 15% since its April low, nearing its all-time high, but indicators suggest it may be overbought with the 14-day RSI hitting its highest level since January. While a slowdown is expected, analysts believe XLF can avoid a significant downturn and potentially form bullish patterns, similar to its performance in the past two years; meanwhile, the European Financials ETF (EUFN) appears even more extended, suggesting that while financial sector strength is a positive sign, investors should consider a "buy the dip" strategy.

Analysis

The Financials Select Sector SPDR Fund (XLF) has exhibited notable strength, advancing 15% since its April 7 intraday low to trade within 1% of its February 28 all-time closing high, a recovery achieved by few US-based ETFs. This rapid appreciation has pushed its 14-Day RSI to 68 as of Monday's close, the highest reading since January 25, signaling near-term overbought conditions and suggesting an impending slowdown in its upward momentum. Historical chart patterns for XLF indicate that RSI peaks, such as the current one, have often preceded MACD sell signals, hinting at a potential consolidation or pullback. Despite this, the fund has a track record of navigating such periods constructively, often forming bullish patterns and resuming its uptrend. The European Financials ETF (EUFN) presents an even more extended picture, having surged over 30% from its April low and registering a very high 14-Day RSI of 77; its MACD has also reached levels last seen in March, prior to a market-related decline. While the robust performance in both US and European financial stocks is a positive indicator for the broader stock market and global economic health, the current technical overheating, particularly in EUFN, warrants attention, aligning with the general market sentiment of 'Neutral' with a 'Cautious' tone.

Key Decisions for Investors

• Investors should anticipate a moderation in the recent strong rally for both XLF and EUFN, considering the overbought signals from their respective RSI indicators, and thus exercise caution with new long positions at current levels.
• A 'buy the dip' strategy for XLF could be considered, looking for entry opportunities during potential consolidations, given its historical ability to form bullish continuation patterns after digesting gains.
• Closely monitor momentum indicators like the RSI and MACD for both ETFs; EUFN, with its significantly higher RSI of 77, may be more susceptible to a sharper near-term pullback compared to XLF.
• While underlying strength in the financial sector is broadly positive, tactical adjustments, such as waiting for a cooling-off period before increasing exposure, may be prudent to navigate the current overextended conditions.