Lehman Brothers (NYSE: LEH) has a lot to answer for… No sooner had I wrapped up this edition of “Sector Watch” than the company declared bankruptcy, thus forcing me into a swift re-write! So much for my plan to go fishing yesterday…

Anyway, with Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) getting bailed out last week, Lehman’s bankruptcy comes at the same time as Washington Mutual (NYSE: WM) and insurance giant American International (NYSE: AIG) teeter on the edge of bankruptcy, too.

So now is the time to take a look at the latest carnage unfolding within the financial sector…

If You’re Investing In Financial Stocks… Here’s What You Need To Do

Despite the recent woes in the financial sector, it actually wasn’t faring too badly. Since the markets bottomed out on July 15, some banks have performed very well. Like BB&T Corp (NYSE: BBT), for example – up a whopping 82% – and US Bancorp (NYSE: USB), which has risen 64%.

Aside from the obvious major problems in both the bank and brokerage sectors, the brokerage stocks, which use more leverage in their businesses, seem to be getting the worst of it. For example, while USB was making a new two-month high last week, Merrill Lynch (NYSE: MER) traded at a 12-year low.

The moral of this story is this: If you’re going to trade the financial sector from the long side, you’d better do your homework and stick with these well-capitalized banks.

On the other hand, you can diversify and lower your risk from the sector through one of its most widely traded ETFs – the Financial Select Sector SPDR (AMEX: XLF)

As you can see below, the stock has remained stuck in a consolidation pattern since late July.

The Offsetting 85

However, this consolidation pattern is a bullish one – and for a good reason.

Because XLF is comprised of more than 85 stocks – mostly including banks, brokers, and insurance companies – when some of them are faring well and some doing poorly, the resulting action is sideways trade.

However, XLF appeared to trigger a daily buy signal off the July 15 lows and unless an alternative upside target is generated, the stock should eventually trade up to at least my minimum target around $24.40.

And that gives investors a good, low-risk opportunity to buy.

That’s because in the wake of the Lehman fallout, the stock will probably trade back down to the bottom of the consolidation pattern in the $19-$20 area. Beware, however…

A Financial World Still Crumbling

If you’re looking to invest in financials in hopes of grabbing some bargains, remember that the sector is still in crisis. Moreover, nobody really knows for sure if other institutions will stumble down the same path to bankruptcy as Bear Stearns and Lehman Brothers.

The best course of action is to wait for the dust to settle and see if XLF can hold the $19 area.

And on a broader scale, the S&P 500’s low for the year is 1,200.44. If the index closes below that level, it should have further to go – in which case, I’d hold off on buying anything until the dust settles.

Commodity Rewind… And Flash Forward

In the last couple of editions of “Sector Watch,” we’ve looked at some of the commodity sectors, including energy and gold, along with their related ETFs.

According to the analysis generated by the trading system I developed for my 1-2-3 Trader service, we noted that they all had bearish daily chart patterns.

And over the past couple of weeks, the US Oil Fund (AMEX: USO), SPDR Gold Trust (AMEX: GLD), and the US Natural Gas Fund (AMEX: UNG) have all made new correction lows.

In fact, USO and GLD have similar chart patterns and they reached my minimum downside objectives over the past week. With UNG, the chart is more complex and it’s hard to tell at this point if the “C” wave (or “3rd wave”) is complete.

Regardless, most of the commodity sectors are now reaching oversold territory and if nothing else, we can probably expect at least a decent rebound to work off the oversold conditions.

USO and GLD are now all set up for daily buy signals, so the risk of being short is increasing.

That also goes for the Powershares Commodity ETF (AMEX: DBC). Let’s take a fresh look at the chart…

We originally highlighted this chart in the August 25 edition of “Sector Watch.” At that time, the stock was trading above $38, and the “C” wave decline was just getting underway. Since then, the stock has made new correction lows and reached my minimum downside objective of $34.60.

So as I said, the same theory as USO and GLD applies here: The chart is set up to trigger a buy signal, so be wary of going short at this point.

We will revisit the commodity ETFs once we see what unfolds from here.

Take care till next time.

Jim

Source: If You Invest In Financial Stocks… Here’s What You Need To Do