ENERGY SHARES LEAD U.S. STOCKS HIGHER -- SMALL CAPS BREAKOUT -- FOREIGN STOCKS ALSO BOUNCE ON FIRMER CRUDE PRICE -- SO DO HIGH YIELD BONDS -- OIL SERVICE STOCKS BOUNCE FROM DEEP OVERSOLD CONDITION AND MAJOR SUPPORT
US STOCKS END WEEK ON A STRONG NOTE... A combination of factors pushed U.S. (and global) stocks sharply higher during the second half of the week. One big factor was the Wednesday Fed statement that it would be "patient" in raising rates next year. Another was a bounce in a very oversold oil market late in the week which gave a big boost to energy shares (which make up 8% of the S&P 500). Energy shares rose 9.5% and were by far the week's strongest sector. Material stocks (led by copper and aluminum) came in second with a weekly gain of nearly 5%. All other sectors gained on the week as well. Chart 1 shows the S&P 500 rallying sharply and nearing a test of its December high. Small caps also had a strong week. Chart 2 shows the Russell 2000 Small Cap Index breaking out to a new six month high. I wrote on Thursday that small caps usually start to do better in mid-December in anticipation of the traditional January Effect. Traders were also buying in anticipation of the traditional yearend Santa Claus rally. [Friday's unusually heavy trading was due mainly to the quarterly expiration of futures and options]. Foreign shares also jumped.
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Chart 1
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Chart 2
FOREIGN STOCKS ALSO HAVE A GOOD WEEK ... In the Americas, oil producers in Canada and Latin America bounced back with energy. In Europe, the London Financial Times Index ($FTSE) gained nearly 4% on the week. Britain is Europe's biggest energy exporter. Stocks also rallied on the continent. Chart 4 shows the German DAX Index rebounding off its 50- and 200-day moving averages. Part of the buying on the continent resulted from a rebound in Russian stocks and the ruble. Chart 5 shows the Market Vectors Russia ETF (RSX) rebounding sharply (in heavy trading) from a very oversold condition. [See 14-day RSI chart on top of chart and heavy volume bars along the bottom). The rebound in Russia and other oil-producing nations resulted from the rally in crude oil from a very oversold condition, and the strong performance in energy shares. That also took a lot of pressure off U.S. stocks which were being held back by foreign weakness.
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Chart 3
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Chart 4
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Chart 5
JUNK BONDS RALLY WITH ENERGY SHARES... Arthur Hill's Friday message showed the 1-year and 2-Year Treasury yields hitting three-year highs this week. That means that traders are selling the shorter-end of the yield curve which is most vulnerable to a Fed rate hike. Traders also sold longer-dated Treasuries, but not as heavily. As Arthur suggested, some of that money may have moved into stocks. Some of it also moved into riskier high-yield bonds which had a very strong week. Chart 6 shows the iBoxx High Yield Corporate Bond iShares (HYG) jumping sharply during the last three days of the week. Part of that may simply have been a willingness to take on more risk (investors also bought small caps more aggressively during the week). The promise of Fed patience in raising rates also increases the appeal of higher-yield bonds. A big part of this week's junk rebound was also due to a strong week in energy shares. The black line in Chart 6 shows a strong correlation between energy stocks (the Energy SPDR) and high yield bonds over the last six months. That's because most selling in junk bonds has been in energy companies. This week's 9% jump in a very oversold energy sector no doubt contributed to some junk bond buying as well. The 60-day Correlation Coefficient (below chart) shows a strong correlation of 0.79 between the two markets.
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Chart 6
OIL SERVICES ETF VERY OVERSOLD AND NEAR CHART SUPPORT... My Wednesday message showed the Energy SPDR (XLE) rebounding off a major support line and in a very oversold condition. Its 9.5% bounce this week was exceeded only by an 11% gain in oil service stocks which had been beaten down even more. Between July and the start of this week, oil service stocks had lost 41% of their value versus a 26% loss for the entire energy sector (XLE). The weekly bars in Chart 7 show that the Market Vectors Oil Services ETF (OIH) has fallen very close to potential support along its 2011 and 2012 lows. In addition, it is bouncing off its 61.8% Fibonacci retracement line measured from its late 2008 bottom to its mid-2014 top. That lower retracement line usually functions as the last line of defense against a more serious price plunge. The fact that the 14-week RSI line (bottom of chart) has fallen to the lowest level (below 30) for the first time since late 2008 also suggest that the price plunge is overdone. That would also be true for crude oil itself. The 60-day correlation between the OIH and crude oil during 2014 stands at a remarkably high .94%. Crude oil, which is in a very oversold condition of its own, rebounded 3.7% on Friday. Crude may not have to rally that much to provide some support to energy shares. All it may need to do is start showing sign of stabilizing. That may be all it can hope for in the face of a stronger dollar.
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Chart 7
US DOLLAR INDEX REACHES EIGHT-YEAR HIGH... One of the side effects of rising short-term Treasury yields is a stronger U.S dollar. That's especially true with the Fed ending its QE bond buying during October and expectations for a rate hike next year. At the same time, Japan is in the middle of a very loose monetary policy (which weakens the yen), and the eurozone is expected to start its own version of QE early next year (which is weakening the Euro). [In addition, 10-year Treasury yields are much higher than comparable yields in Europe and Japan]. That's all bullish for the U.S. dollar and its chart reflects that. The monthly bars in Chart 8 show the U.S. Dollar Index ($USD) ending above its 2009 peak and trading at the highest level since 2006. The USD appears to be completing a major bottoming pattern that started in the middle of the 2008 financial collapse. A rising dollar is usually negative for commodities like oil that are priced in dollars. [Over the last decade, the correlation between the dollar and crude oil has been a negative -0.78%]. Chart 8 also shows that the dollar bottom in mid-2008 ended the major uptrend in the CRB Index and crude oil that started with a dollar peak in 2002. Since July 2008, the USD has gained +24% while the CRB Index lost -48% and crude oil fell -60%. [Since this July, the USD has rallied 12% while the CRB and oil have lost -22% and -46% respectively]. All of which suggests that a stronger dollar going forward should act as a restraint on commodity prices, oil included. That may challenge Janet Yellen's belief that the drop in oil (and other commodities) is only "transitory". One positive effect of a stronger dollar is that makes U.S. bonds and stocks more attractive to foreign investors.
