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Minyan Mailbag: Chemical Imbalance?

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Looks a little scary to me

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Kevin,

Noticed, over the last couple weeks, relative outperformance of the CBOE S&P Chemicals Index (CEX) and its related components.

Notably: E.I. du Pont de Nemours and Company (DD), The Dow Chemical Company (DOW), Rohm and Haas Company (ROH), Praxair, Inc. (PX), Air Products & Chemicals, Inc. (APD), Avery Dennison Corporation (AVY), Eastman Chemical Company (EMN).

PNF thoughts?

Thanks,
Minyan Michael


MM-

Great question. I'll show you how I evaluate the significance of the relative strength relationship you have spotted. Outperformance for a financial instrument can occur in one of two ways; by virtue of going down less than what the instrument is being compared against, or by rising faster than what the instrument is being compared against.

I looked at the CEX vs. the S&P 500 to determine the relative strength.

The chart below shows the CEX has indeed reversed up on a point & figure basis versus the SPX, indicating the relative outperformance you mentioned. The reversal is very recent, having occurred on October 26.



Now, I want to understand what kind of relative outperformance we are seeing. Is the outperformance positive in an absolute sense, or negative in an absolute sense.

Since Oct. 26, the reversal up for the CEX vs. SPX, the CEX is down .286% while the SPX is down 1.05%. Negative absolute performance.

This is not surprising since the market indicators I use say the overall context of the market is negative. Moreover, when I look inside the CEX at the individual issues, I see the components themselves are mostly trading in a negative context. Only 30% of the components of the CEX are on a point & figure buy signal, and only 38% of the components are in a long-term positive trend. The chart below shows the CEX has recently bounced off long-term multi-year trendline support, but remains on a sell signal. CBOE S&P Chemicals Index (CEX)


This to me suggests the CEX outperformance is a lesser of evils event. In other words, if you have to be long stocks when the tide fo the broad market is negative (and for a variety of reasons many people do - after all, there is a certain risk involved in not being invested in stocks -) then you at least want to be in those sectors that are showing relative outperformance regardless of whether that outperformance is positive or negative in an absolute sense. Sectors and stocks that are outperforming during negative environments tend to be leaders in positive environments.

No positions in stocks mentioned.

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