DROP IN ENERGY SECTOR GIVES MARKET A BOOST -- SO DOES A BOUNCE IN FINANCIALS -- GLOBAL MARKETS STILL TESTING 200-DAY LINES
ENERGY ETF LOSING LEADERSHIP... A strange thing happened this week. Crude oil prices reached another all-time high. At the same time, energy shares dropped. Chart 1 shows the Energy Select Sector SPDR trading under its 50-day average for the last four days of the week. The previous week's rally fell well short of its April high. More importantly, the relative strength line is starting to weaken. Normally, relative weakness in energy shares hints at some softening in the price of crude oil. News on Friday of a possible boost in energy production pushed crude oil $1.00 lower and back below $40. Any hint of weakness in energy prices -- and energy stocks -- is potentially good news for the stock market.
Chart 1
ENERGY VS. THE S&P 500... Chart 3 gives a longer-range look at the Energy/S&P 500 ratio. It can been seen that when the energy RS line is falling, that's generally good for the market. The peak in the ratio last March (first circle) coincided with a major bottom in the S&P 500. The ratio line turned up at the end of 2003 (see arrow) . Within a month, the S&P 500 had started to drop. To the upper right of Chart 2 (second circle), it can be seen that the ratio line is starting to back off from potential resistance at the high of last spring. Any serious drop in the relative performance of the energy sector should be a supportive influence for the S&P 500, which is trying to stabilize at its 200-day moving average. At the same time that energy shares are starting to underperform, finanical shares are starting to outperform. That should also be good for the market -- if it continues.
Chart 2
Chart 3
FINANCIALS ARE REBOUNDING... Financial stocks are the flip side of energy. When energy stocks are outperforming the market, rate-sensitive financials usually underperform. That's been the case over the last two months. But it may be changing. Chart 4 carries two important pieces of information. One is that the Financials Select Sector SPDR is trading back over its 200-day average. The second is that its relative strength has turned up. Since mid-March, the financial sector has been one of the market's worst performers. That was due to the inflationary impact of rising oil prices on interest rates. That's why this week's better performance by financials is an encouraging sign.
Chart 4
EAFE INDEX TESTING 200-DAY LINE... At midweek, I talked about a number of global markets that were also in the process of testing their 200-day lines. The next chart shows it better. The EAFE is an index of foreign stocks in Europe, Australia, and the Far East. It doesn't look much different than the American market. And that's exactly the point. The recent downturn in stocks has been global in scope. And so is the current test of major support at the 200-day moving average.
Chart 5
STILL WATCHING THE TESTING PROCESS... Very little changed over the last week. The market has been falling due primarily to the threat of rising energy prices and rising interest rates. The stock market drop has been global in scope. For the last two weeks, stock markets around the world have been trying to stabilize near their 200-day moving averages, which is normally a major test of long term support. So far, the issue is still very much in doubt. Until the matter is resolved one way or the other, we continue to advocate a generally defensive market posture. There are times to trade and times to watch. This is one of the times to watch and wait.
