The financial sector has been challenged from every direction and continues to lag the broader markets. Taking a look at the chart below of XLF, SPDRs Select Financial ETF the sector is poised to break through resistance at the $15 level. Based on the technical data the breakout would be a positive from the three month consolidation range. The question mark is can the technical data overcome the fundamental weakness in the sector?

Taking a closer look at the chart we see volume has been declining during the rise off the July low. We could dismiss this and say that is true of the broader market as well. However, that is the challenge with the broader market rally also. The series of higher lows and higher highs is at a key pivot point to maintain the short term uptrend. This bares watching and giving room before committing capital to the sector.

Fundamentally the issues run deeper and the challenges facing the sector are bigger to overcome. Earnings reports were positive for the second quarter, but the fundamental structure of expenses to revenue are rising and this creates a problem. Cost cutting will be the primary way the sector deals with profit. The ability to increase revenue is shinking due to less lending in the capital markets. Credit card, mortgages and private capital financing have all reduced considerably over the last six months. It was just reported by the mortgage lenders, nine consecutive months of contracting mortgage business. The housing problem is still far from over. All of this adds up to challenges relative to revenue for the major institutions. Throw in financial regulatory reform and you have additional problems thrown on top of the already revenue burdened sector.

Where does this leave us relative to the owning the sector? From an investment stand point, I would avoid the broad sector and focus on specific stocks which are bucking the trend or have a unique niche in the market place. From a trading perspective, a momentum breakout technically would be worth trading based on a defined strategy, but no more than a trade.

We will have to be patient about building any longer term positions in the sector and look for the balance sheets to improve fundamentally over time.