ENERGY SPDR HITS RECORD HIGH AS OIL BREAKS OUT -- THAT COULD BE BAD FOR BONDS AND STOCKS
ENERGY BREAKOUTS... Several previous messages have talked about upside breakouts taking place in energy stocks. And that trend has only gotten stronger both in the stocks and the commodity. The upper box in Chart 1 shows the price of WTIC crude oil rising to the highest level since last November. The price of crude started rising three months ago which is when energy stocks started rising. In fact, they've been the market's strongest sector since June. And they achieved an upside breakout of their own. The lower box in Chart 1 shows the Energy SPDR (XLE) exceeding last year's high to end the week at a new record. As also explained in a previous message, however, energy leadership carries good and bad news. The good news is rising energy prices push energy shares higher. The bad news is that rising energy prices are potentially inflationary and can push interest rates higher. Energy leadership historically has usually also been bad for stocks.
RISING OIL BOOSTS BOND YIELDS... Chart 2 shows a relatively close relationship between the price of crude oil (black bars) and the ten-year Treasury yield (green line) over the last year. The chart shows both declining on the left side of the chart and rising together on the right side. They both started bottoming together between April and June (see circle) and have been rising together since then. The line in the lower box shows the 60-day Correlation Coefficient between the two markets rising to 75% which reflects a positive correlation between them. That makes economic sense since rising energy prices are potentially inflationary which normally results in higher interest rates.
ENERGY LEADERSHIP ISN'T GOOD FOR STOCKS... This is one of the hallmarks of intermarket analysis. That's because rising energy prices boost interest rates which is usually bad for stocks. That relationship can be seen in Chart 3 which compares the S&P 500 (black bars) to the XLE/SPX ratio (gray area) over the last two years. The main point of the chart is that energy leadership (rising ratio) has usually coincided with falling stock prices. While energy weakness (falling ratio) has usually coincided with higher stock prices. An upturn in the XLE/SPX ratio in early 2022 coincided with a peak in the SPX (see arrows). A peak in the ratio last November helped launch a stock market rally which is still intact. The big question now is whether the recent upturn in the XLE/SPX ratio (energy leadership) has a negative impact on stock prices. And that may depend on whether or not the ten-year bond yield exceeds the previous high reached late last year.
