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A Case for Shorting the Financials

Editor's note: This piece originally ran earlier today on our newest Premium service, ETF Profits . Click here for a 14-day trial to this exciting product!

They say that money makes the world go round. But if the firms that lend and invest money are having difficulties, what does that mean for the other sectors of the market? The function of the financial sector is to efficiently supply capital to aid the real economy. This sector is a tool to help the firms that make the real tools.

Using the Financial Select Sector SPDR (XLF) as a benchmark, the sector appears to be starting a downtrend. Yesterday, the ETF fell below its 50-day moving average. Over the past few weeks, it has established a price pattern of lower highs and lower lows. This could be a bad omen for financials and, subsequently, the rest of the market.

It is well documented that the economy's troubles over the last few years stemmed from overleveraged financial firms. Most of the money spent on the global bailout went to this sector. Governments have printed trillions of dollars in an effort to shore up the balance sheets of banks, brokerages and insurance companies.

With many financial institutions on the mend, it appears that the bailouts were largely successful. That said, the sector has yet to even come close to approaching the peak values set back in 2007. A downturn now could knock the struggling economic recovery off its tracks.

Financials are currently being supported by the Fed's $600 billion quantitative easing (QE) program. This program allows banks to sell bonds to the Fed at a profit and thus creates liquidity. This program is set to expire in June. Meantime, markets, as they do, may be starting to discount the end of the free-flowing money.

Bill Gross, co-CEO of PIMCO, recently wrote: "A successful handoff from public to private credit creation has yet to be accomplished, and it is that handoff that ultimately will determine the outlook for real growth." Gross added that the end of the Fed's Treasury-buying program in June may not bode well for the U.S. economy. There could be "dramatic consequences in the reverse direction," he said. If the economy cannot manage after the expected end of the Fed's Treasury purchases on June 30, "then the QEs will have been a colossal flop," Gross Concluded.

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