Energy Stocks Break Out vs Financials
- Posted by JC Parets
- on May 6th, 2014
A big theme that we’ve been focusing on lately is the rotation into Energy stocks and out of some of the early cycle sectors. Today I want to specifically point to last month’s breakout in Energy vs the Financial sector ($XLE vs $XLF). After several years of underperformance, it’s now the Energy names leading the way and making new highs while each of the Financial components break down one by one. They’re dropping like flies these days.
Last week, Bank of America gapped lower on Monday morning after news of some accounting error or something. The media likes to blame that for the sell-off, but technicians know this stock had already been selling off well before that announcement (see here). This week we come into the office and it’s JP Morgan who’s gapping lower to start the week, closing Monday near 6-month lows. Who knows what the excuse is for this one, maybe the weather or Ukraine or something. Regardless of the “reasons”, all of these banks, one by one are getting crushed.
Meanwhile, Energy stocks are hitting 52-week highs and even all-time highs in some cases. It’s this late cycle sector that’s making the big moves lately. Here is the chart showing the XLE breaking out vs XLF last month and following through nicely to start May:
I don’t care how you draw your trendlines; Energy is breaking out above all of them. Notice how this was all happening as momentum had been diverging positively all year long.
Here is the same breakout but from a different perspective. This chart shows both the Energy and Financials relative to the S&P500 since the end of March. One of them has gone straight up and the other straight down:
Energy is by far and away the best sector over the past 5 weeks up almost 6% while financials are by far the worst during the same period. I think based on this breakout in the first chart above, this trend is likely to stay.
There are a few things we can gather from this action. #1 and most obvious is that Energy is clearly where we want to be, especially on a relative basis. Financials on the other hand are a sector we want to be fading on any strength. #2 is that money is flowing heavily into late cycle sectors and out of the early cycle names, which is overall bearish for stocks as an asset class. And finally #3 is the answer to why the S&P500 is holding up better than the other US stock market averages. The market capitalizations for these Energy names are some of the biggest that we have (think Exxon, Chevron, etc). This rotation has helped the averages avoid this whole gravity problem.
The last thing I wanted to mention is the lack of correlation between Crude Oil and Energy stocks. People are obsessed with comparing the two for some reason. The numbers, on the other hand (the truth), don’t add up. The 1-year correlation coefficient between $XLE and Crude Oil is the same as Bluto Blutarsky’s grade point average: Zero Point Zero. If you want to go back a little further, the 5-year correlation coefficient between the two is also zero point zero. So be careful who you listen to. Oil has done literally nothing for years now while Energy Stocks are at all-time highs. One thing has nothing to do with the other.
We can definitely see this energy rally continue, but I just want to reiterate that the real action here is on a relative basis. We’re not just seeing Energy breaking out compared to the S&P500, but most importantly vs the early cycle sectors. There’s a lot of information we can take from this. I hope this adds some value to what you’re already looking at.
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J.C. Parets is the Founder & President of Eagle Bay Capital, LLC. He earned the Chartered Market Technician designation (CMT) and is a member of the Market Technicians Association. More
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