ENERGY STOCKS REMAIN IN FOURTH QUARTER CORRECTION -- WHY THAT'S NOT NECESSARILY GOOD FOR THE STOCK MARKET
OIL SERVICE HOLDERS STILL IN CORRECTION ... On September 14 I wrote an article showing that the energy sector had moved into a long-range overbought condition. That article, however, allowed for more short-term buying until the short-term trend also became overbought. On September 23, I wrote that oil appeared to be putting in a short-term top and that negative divergences had appeared on the daily indicators of energy Exchange Traded Funds (September 23, 2005). I wrote that the Oil Service Holders looked toppy. Two of the reasons were the negative divergences on the 9-day RSI line (blue arrow) shown in Chart 1 and the MACD lines (red down arrow). I suggested some profit-taking at that point and even more if the 50-day line was broken. Not only was the 50-day line broken, but the OIH did so on very heavy volume. As of now, the OIH and the rest of the energy complex remains under pressure. The 9-day RSI line is near oversold territory, but the MACD lines are decidedly negative. The recent bounce took place on lighter volume. That suggests to me that the OIH may be headed down toward its 200-day moving average which sits near 100. There's another chart reason why the 100 level is important.
Chart 1
WEEKLY CHART ALSO LOOKS TOPPY ... The weekly bars in Chart 2 put the pullback in the Oil Service Holders in better perspective. The chart shows that the red 40-week moving average (or the 200-day line) has acted as a good support level over the last two years. Right now, that line sits near 100. Notice, however, that the 100 level also matches the previous peak formed in late 2000 which was exceeded earlier this year. In chart work, a downside correction should find support around its previous breakout point. That tells us two things. There's a good chance that the 100 level will be tested in the OIH. Secondly, that prices must stay above that level to keep their long-term uptrend intact. That view calls for more short-term caution until the OIH moves closer to its long-term moving average, or until it shows convincing signs of turning back up again. Another negative factor is the downturn in the weekly MACD lines (second red circle) which is occurring from the same level as the downturn in late 2000 (first red circle). It's not unusual for crude oil and stocks tied to oil to correct or consolidate during the fourth quarter. I suspect that process will continue through the balance of the year. That was why I recommended some profit-taking in energy stocks. I also recommended switching some energy funds into the natural gas group. A September 28 article explains why I believe that natural gas holds better value than crude oil (September 28, 2005).
Chart 2
WHY WEAK ENERGY SECTOR ISN'T ALWAYS GOOD ... I wrote recently that loss of energy leadership could be a mixed blessing for the stock market. That's because rising energy prices often occur at the end of economic expansions (and bull markets). That pushes the Fed into a tightening mode which usually contributes to market selling. Sector rotation work shows that a peak in energy stocks often coincides with or follows a market downturn. That may partially explain why the market hasn't reacted better to the drop in energy. If the market is going to benefit from falling energy prices, other stock groups have to take over market leadership. Those include financials, retailers, transportation, and technology which are usually the first to rally in a market upturn. That's where I'd be looking for signs of a market bottom. If those groups don't start doing better, then falling energy shares can become a bad thing for the market.
