DOW INDUSTRIALS HEADING FOR TEST OF 2007 HIGH -- A NEW RECORD HIGH BY INDUSTRIALS WOULD CONFIRM TRANSPORTATION BREAKOUT -- ASSET ALLOCATION SHIFT FROM BONDS TO STOCKS -- ENERGY ETFS NEAR BREAKOUTS
DOW INDUSTRIALS NEARS 2007 HIGH ... One of the oldest ways to determine the trend of the stock market is to compare the action of the Dow Transports and Industrials. Dow Theory holds that both indexes need to be in uptrends for a market uptrend to exist. As we've pointed out in several previous messages, the Dow Transports (which is more economically-sensitive) has already exceeded its 2007 peak to reach a new record (Chart 1). Chart 2 shows the Dow Industrials nearing a test of its 2007 peak. Both are currently in uptrends. A new record high by the Dow Industrials would add further confirmation that the stock market is headed higher.
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Chart 1
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Chart 2
STOCKS ARE OUTPERFORMING BONDS ... Since 2000, Treasury bonds have been stronger than stocks. That was largely due to deflationary pressures over the last decade and two major stock market selloffs. But the pendulum appears to be shifting back to stocks. Chart 3 plots a "ratio" of the S&P 500 divided by the 30-Year Treasury Bond Price. The stock/bond ratio fell sharply between 2000 and 2002 and again during 2007 and 2008. Notice that the 12-year ratio is contained between two falling parallel trendlines. The ratio bounced off the lower line during 2009, and has been rising since then. Stocks have done better than bonds over the four years since then. The ratio still needs to break through the upper line (drawn over 2000/2007) peaks to signal that the major pendulum has shifted from bonds to stocks. But it appears to be headed in that direction.
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Chart 3
STOCK/BOND RATIO IS TURNING UP ... Chart 4 shows a "ratio" of the S&P 500 divided by the 20+Year T-Bond iShares (TLT) during the four years since 2009. The stock/bond ratio rallied from spring 2009 to early 2011 as stocks rose faster than Treasuries. The ratio fell during 2011 as stocks corrected downward and bonds rallied. The ratio trended sideways during 2012 (as Fed buying kept a strong bid under Treasury prices). To the far right, however, the ratio has broken the down trendline extending back for a year and appears to breaking out to the upside. That suggests that the asset allocation pendulum is swinging away from bonds and back to stocks. In my view, the "great rotation" out of bonds and into stocks is being delayed by the Fed's policy of quantitative easing. By keeping bond yields artificially low, it's also keeping bond prices artificially high which has kept retail investors in Treasuries. Sooner or later, market forces will take their natural course and bond yields will start rising along with stocks. Falling bond prices will force investors out of bonds and into stocks. I suspect some investors have figured that out and are already starting that asset allocation rotation.
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Chart 4
ENERGY ETFS NEAR UPSIDE BREAKOUTS ... The energy sector is quietly advancing in sector rankings. Energy has been the past week's second strongest sector (behind industrials). The weekly bars in Chart 5 show the Energy Sector SPDR (XLE) breaking through a resistance line drawn over 2011/2012 highs (see circle). It's also on the verge of a new 52-week high. The XLE/SPX relative strength ratio (gray line) is also turning up. Chart 6 shows the Market Vectors Oil Services ETF (OIH) testing a trendline drawn over its 2012 high. It's RS ratio (gray line) is turning up as well.
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Chart 5
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Chart 6
CONOCOPHILLIPS AND EOG RESOURCES ARE XLE LEADERS ... Scanning through the top ten holdings in the XLE uncovered the two following leaders. The weekly bars in Chart 7 show ConocoPhillips (COP) having already broken out to the highest level in five years (see circle). Chart 8 shows EOG Resources (EOG) having done the same thing (see circle). Those two bullish breakouts increase the odds for a stronger energy sector.
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Chart 7
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Chart 8
OIL SERVICE LEADERS INCLUDE HALLIBURTON AND SCHLUMBERGER... Two of the largest holdings in the Oil Service Holders (OIH) are also in the process of achieving bullish breakouts. Chart 9 shows Halliburton (HAL) clearing a resistance line drawn over its 2012 highs (see circle). HAL is also trading over its September intra-day high at 37.90. Chart 10 shows Schlumberger (SLB) having broken a resistance line as well (see circle).. SLB is trying to climb over its September intra-day high at 78.16. Although oil service stocks have lagged behind the rest of the energy complex, they're starting to show signs of catching up.
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Chart 9
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Chart 10
GOLD MINERS BULLISH PERCENT INDEX CONTINUES TO DROP ... Last Tuesday's message compared the Market Vectors Gold Mining Index (GDX) to the Gold Miners Bullish Percent Index ($BPGDM) looking for signs of an upturn. [That index shows the percent of gold stocks in point & figure uptrends]. Chart 11 shows the GDX (black bars) failing a test of initial chart resistance near 44 (black arrow) and falling back to the 30 level. The orange line shows the BPDGM falling below 25. That keeps the gold mining downtrend intact. The P&F boxes in Chart 12 also show that the BPGDM would now have to rise three boxes (six points) to 32 to turn its trend positive.
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Chart 11
