Financial stocks get hit hard by market sell-off

— -- Financial stocks are finding themselves back in the liability column in many investors' portfolios.

Shares of the nation's banks, brokerages and insurers were trashed Tuesday amid a vicious market sell-off, dashing hopes financials have seen the worst and raising doubts about last week's broad market rebound. The Financial Select Sector SPDR, which tracks a basket of financial stocks, tanked 4.1% — a notably poor performance even when the Standard & Poor's 500 declined 3.2%.

"Things are looking bad again," says Eric Fitzwater, analyst at SNL Financial. Every time economic data are released that open discussion of a recession, "Financial stocks fall back into the hole," he says.

While financials are just one sector of the economy, investors are watching closely because they have been a:

•Leading indicator. Since much of the economy's trouble is centered around lending and credit markets, financial stocks have been early to react to news and have set the pace for the declines.

"Everyone is getting abused," says Jeff Tyler, portfolio manager at American Century. "But we continue to see more and more concern about financials."

•Recent glimmer of hope. Financial stocks hit bottom on Jan. 18 and staged a 16% rally through Feb. 1. Investors hoped interest rate cuts by the Federal Reserve would fix problems faced by banks, says Jeffrey Harte, analyst at Sandler O'Neill.

But economic data released Tuesday showing the service sector shrank for the first time in nearly five years tested faith in a recovery, Harte says. "The mentality went from: 'The Washington cavalry has arrived' to 'Maybe this is deeper than we thought,' " he says.