WEAKNESS IN ENERGY CONTINUES ROTATION INTO AIRLINES, BANKS, AND RETAILERS -- FOURTH QUARTER RALLY CONTINUES -- WHERE WE ARE AFTER THAT

ENERGY STOCKS SELLOFF ON WEAK OIL ... With crude oil falling to a three-month low, energy stocks are coming under heavy selling pressure. On Monday, I showed the Energy Sector SPDR (XLE) falling back below its 50-day moving average. It's fallen even further since then. Chart 1 shows the XLE heading down towards its October low and another test of its 200-day average. Downside volume has picked up which is a negative sign. Chart 2 shows the Oil Service Holders (OIH) falling beneath their 50-day line after an unsuccessful challenge of their late-September peak. Downside volume is picking up there as well. Utility stocks, which have been closely tied to energy, are also coming under more pressure. Chart 3 shows the Dow Utility Average heading back toward its 200-day line. As has been the case since October, weakness in those two groups has spared a sector rotation into fuel-sensitive groups like airlines and and banks. Those two groups continue to show market leadership during the yearend rally and are two of the day's strongest groups.

Chart 1

Chart 2

Chart 3

AIRLINES AND BANKS BENEFIT FROM WEAK OIL ... Charts 4 and 5 show the continuing rally in airlines and banks. [They were also the market's two top performers during the month of October]. Chart 3 shows the Airline Index reaching a three-month high after clearing its 200-day average. Airlines are especially sensitive to the cost of fuel. Chart 4 shows the Bank Index (BKX) challenging its July peak. The upturn in both relative strength ratios shows that the rotation into airlines and banks started right around the time that energy stocks peaked. I believe that the flow of funds back into bank stocks is due to reduced inflation pressure from falling energy prices and some steepening of the yield curve from the recent rise in bond yields.

Chart 4

Chart 5

EXXON'S LOSS IS WAL MARKET'S GAIN ... The sector rotations resulting from weaker energy pricing is seen very clearly in the next two charts. Exxon Mobil peaked at the end of September along with its relative strength ratio (Chart 6). The big energy stock is now meeting resistance at its 200-day moving average. In contrast to that, Wal Mart and its relative strength ratio (Chart 7) bottomed at the exact same time that XOM was peaking. Retailers are also benefiting from the drop in oil (since it gives consumers more spending money). And Wal Mart is the biggest retailer of them all. In today's trading, WMT is trading above its 200-day average for the first time in a year. Exxon's loss is Wal Mart's gain.

Chart 6

Chart 7

REITS ARE BOUNCING ... Along with housing stocks, REITs have been market losers since early August. The rate-sensitive group is starting to show some bounce however. Chart 8 shows the Real Estate iShares (IYR) climbing above their 50-day average after recently regaining their 200-day line. Upside volume is starting to look good. In addition, the 9-day RSI line has turned up as have the MACD lines. I suspect the REITs are rallying for the same reasons that other rate-sensitive stocks are. I doubt that their rally is the start of a major upturn. But some money is starting to flow back into REITs.

Chart 8

WHERE WE ARE ... A month or two back I wrote that energy prices usually peak during October and that energy stocks would probably spend the fourth quarter correcting or consolidating. The tendency for oil to peak in October partially accounts for the tendency of the stock market to bottom during the same month. Seasonal factors also turn positive for stocks from November to January which is traditionally the three strongest months of the year. After the new year, however, the market has often shown a tendency to weaken again. [Historically, October has been the best month of the year to commit new funds to the market, while January has been the best month to take some funds out]. Certain groups tend to show new leadership in any market rally -- including banks, retailers, technology, and transportation. So far, those groups have done their part to help lead the market higher and lends more credibility to the yearend rally. The bigger question is what happens after that. I happen to believe that energy prices (and gold) are still in long-term uptrends that will probably resume in 2006. That will keep upward pressure on long-term rates around the globe. That's partly due to the global shift from deflation to inflation which is evidenced by new leadership coming from Japan. The last major market bottom took place in October 2002. The four-year cycle calls for the next major bottom to occur in October 2006. That increases the odds that the first nine months of the new year could be tough on stocks. I believe that rising interest rates will become more of a factor in 2006 which will hurt housing and the rest of the economy. The moral of the story is that the market may continue to do better between now and the end of the year. After that, I think things could start to take a turn for the worse.

TRAVEL TIME ON FRIDAY ... I'll be leaving early tomorrow morning to attend a family wedding in Florida. My next market message will be next Monday. In the meantime, I don't see any trend changes taking place over the short run that changes anything that I've written recently. In the meantime, keep an eye on your charts. You don't need to me to tell you what's going up or what's going down. You can see that for yourself on the charts and indicators provided by Stockcharts. On a daily basis, keep an eye on the Market Summary page which tells you at a glance what groups are up and which ones are down. That's the way I start each day. There's a wealth of market information available to you on Stockcharts.com. The best advice I can give anyone is to learn how to use it. I view my job as spotting important turning points in the markets and the various groups in those markets. And then trying to explain what they mean. You have the tools to take things from there. To paraphrase an old clothing commercial: An educated consumer is our best customer. The more you know about technical analysis, the more value you'll get from my market mesages and the charts and tools available on this site.