This Sector is Likely to Outperform the NASDAQ in a Major Way
Back in AprilandMay, I wrote about the possibility that the tech-dominated NASDAQ had begun to lose its mojo. The argument was based more on relative action than the absolute price, as I was, and still am, bullish on the primary trend.
Recent NASDAQ Underperformance is Likely to Extend
Chart 1 sets the scene with the NASDAQ relative strength line, which completed a large complex head-and-shoulders top in May. Immediately after, it looked very much as if that break would turn out to be false, since the RS line subsequently worked its way back above the neckline. However, it never managed to re-cross its red 200-day MA.
Chart 2 focuses on the post-breakdown period, where you can see that the RS line looked as if the breakdown formed part of an inverse head-and-shoulders pattern. Had it been completed, the previous top formation displayed in Chart 1 would have been canceled. That did not happen, as the ratio was unable to surpass the 200-day MA and the potential neckline, both of which were in the same vicinity. Whenever you can spot a reliable moving average and a good trendline overlaying each other, it reinforces that area as a resistance zone. In this instance, that resistance proved to be overwhelming. As a consequence, the RS line has now dropped below the dashed red up trendline, joining the head with the potential right shoulder. In most cases, that kind of action is sufficient to indicate that the pattern in question has failed. It also represents a warning that new lows are likely. Finally, the 25-day ROC, in the bottom window, has violated an up trendline in sympathy with the RS line itself. Chart 1 also shows the KST to be in a negative mode.
It's important to remember that this is an analysis of relative action. Whilst that suggests that the NASDAQ will continue to underperform the S&P Composite, it by no means precludes the Index itself from registering new bull market highs.
NASDAQ versus Energy
Sectors flow in and out of fashion and the NASDAQ will not prove to be an exception. In that respect, one of the key relationships I discussed in May was the long-term cyclic one between the tech-dominated NASDAQ and the energy sector. At the time, there was insufficient evidence to conclude that the 2008-2020 trend favoring the NASDAQ had terminated, though that looked to be a likely proposition. Now more data is available, leading me to believe that the odds more strongly favor a reversal in that trend.
Chart 3 plots the ratio between the NASDAQ and the NYSE Oil Index. In 2000, it reversed trend to the downside by penetrating a head-and-shoulders neckline and its 24-month MA. Fast-forwarding to the current situation, we see the exact same combination with one proviso, which is that the chart is plotted on a month-end basis. We are currently in the first full trading week for October; consequently, the break is not yet an official one.
A powerful reason why it is likely to happen comes from the 18-month ROC in the lower window. It has clearly reversed from an exceptionally high reading, as was the case at the 2000 peak. Achieving a reading of 200% is a pretty big deal because it means that prices have doubled in an 18-month time span. By way of comparison, the all-time S&P peak in 1929 was less than 100%. When the ROC reverses from such a level, it usually indicates that buyers have exhausted themselves. Research over numerous stock markets, commodities and currencies, going back multiple decades in most cases, reveals that a reading in excess of 200% is definitely in nose-bleed territory. The research shows that, when the ROC peaks from such a reading, that level is not surpassed for an average of 15 years.
Chart 4 tells us that the moment of truth is upon us. In this instance, the ratio has been plotted using the SPDR Energy ETF, the XLE. Once again, it looks like it may be in the terminal phase of completing a head-and-shoulders top, as this relationship is currently resting on a potential neckline. Since the short- and long-term KSTs are in a bearish mode, a downside penetration is a more likely outcome.
If you really want to roll the dice and compare the NASDAQ to more leveraged energy plays, Charts 5 and 6 show that two such relationships have already completed a downward-sloping head-and-shoulders. In Chart 5, we see the iShares US Oil and Gas ETF (IEO), whereas Chart 6 features the VanEck Vectors Unconventional Oil and Gas ETF (FRAK).
Please remember it's possible to update these charts simply by clicking on them.
Good luck and good charting,
Martin J. Pring
The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Groupof Walnut Creek or its affiliates.
