THREE-YEAR HIGH IN OIL MAKES ENERGY MARKET LEADERS -- S&P OIL & GAS EXPLORATION & PRODUCTION SPDR BREAKS OUT -- OCCIDENTAL AND EOG ARE XOP LEADERS -- RISING OIL AND BOND YIELDS EXPLAIN WHY ENERGY SHARES ARE DOING BETTER THAN UTILITIES
ENERGY SHARES HAVE BECOME MARKET LEADERS... This shouldn't come as news to readers of this website. Articles written by myself and my colleagues at Stockcharts.com have been bullish on crude oil and energy stocks since the first quarter. So this is just an update of an ongoing story. The price of crude oil has surged to the highest level in three years. Yes, the U.S. pulling out of the Iran deal is a catalyst in today's rally. But crude oil has doubled in price since the start of 2016 and hit a three-year high in January of this year. So this is not a new story. Not surprisingly, energy shares are the strongest part of the stock market today. The weekly bars in Chart 1 show the Energy SPDR (XLE) nearing a test of its January high. The XLE reached a three year high during that month. That has enabled energy shares to go from market laggards to market leaders. That can be seen in the XLE/S&P 500 relative strength ratio (solid line) which has been rising since March. That ratio has risen to the highest level since last spring. The fact that a lot of money managers are underweight the energy sector is forcing them to play catchup.
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Chart 1
S&P OIL & GAS EXPLORATION & PRODUCTION SPDR IS BREAKING OUT... Chart 2 shows an energy ETF that's doing even better than the entire energy sector. The weekly bars in Chart 2 show the S&P Oil & Gas Exploration & Production SPDR (XOP) rising above its January high to the highest level since late 2016. The XOP is this year's strongest energy ETF (its 12% gain doubled the 6% XLE gain). A number of stocks in the ETF are showing big gains today with very strong chart action. The weekly bars in Chart 3 shows Occidental Petroleum (OXY) surging to the highest level in more than three years. Its relative strength ratio (solid line) is rising as well. Chart 4 shows EOG Resources (EOG) nearing a new record. Its relative strength ratio is also rising.
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Chart 2
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Chart 3
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Chart 4
RISING OIL AND BOND YIELDS FAVOR ENERGY SHARES OVER UTILITIES ... This also isn't a new story. Previous messages have described the positive correlation between rising energy prices and bond yields (Chart 5). That's because rising energy prices are inflationary which boosts bond yields (while hurting bond prices). It's no coincidence that both markets have hit three-year highs this year. Bond yields are again testing the 3% level. Their close correlation also explains why energy stocks are doing so well this year, while bond proxies like utilities are market laggards. Chart 6 plots a "ratio" of the Energy SPDR (XLE) divided by the Utilities SPDR (XLU) over the past three years. The XLE/XLU ratio bottomed last August and has been rising since then. Energy shares have gained 6% this year while utilities have dropped -5% (while the S&P 500 has been basically flat). That's what happens when the market starts to price in higher energy prices (rising inflation) along with higher interest rates. While energy shares are today's strongest sector, utilities are the day's weakest. Rising bond yields are boosting financial stocks today.
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Chart 5
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Chart 6
RISING CRUDE PRICE HELPS RAILS WHILE HURTING AIRLINES... Rising oil prices may also explain why railroad stocks are rising today while airlines are falling. The black line in Chart 7 shows the Dow Jones Railroad Index rising to a four month high, while the DJ Airlines Index is falling to the lowest level in six months (red line). Rising fuel costs are a big drag on airlines. As a result, airlines are hit harder when oil prices are rising. By contrast, it's easier for railroads (and truckers) to pass those rising fuel costs onto their customers. So they're less impacted by rising prices. Railroads also transport a lot of crude oil and, as a result, actually benefit from rising demand for oil.
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Chart 7
SMALLER STOCKS ARE LEADING THE WAY HIGHER ... The fact that smaller stocks are doing better than large stocks is usually a good sign for both. Chart 8 shows the S&P 600 Small Cap Index nearing a test of a "flat" trendline drawn over its 2018 highs. A close above that resistance line would complete a bullish "ascending triangle" formation. Chart 9 show the S&P 600 Mid Cap Index trying to clear a falling trendline drawn over its February/March highs. That would signal an upside breakout. Chart 10 shows the S&P 500 Large Cap Index still below that falling trendline, but trading above its 50-day average (blue circle). If it can clear that initial hurdle, a test of its downtrend line should be next. The fact that smaller stocks are leading the way higher increases the odds that the S&P 500 will follow them upward. A break of the upper trendline by the SPX would signal a positive resolution of the triangular formation that started more than three months ago. An upside breakout by the SML would make that a lot more likely.
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Chart 8
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Chart 9
