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Point & Go Figure: Is the Oil Service Outperformance Nearing an End?


All things must pass.


Short-term Overview:
The short-term conditions remain negative with the Percent Above 50-day Indicator for the NYSE, Nasdaq Composite, Russell 2000 and Dow Jones Industrial Average all negative and showing continued deterioration.

The S&P 500 50-day MA Indicator reversed up on Friday and the Nasdaq-100 and S&P 100 50-day MA Indicators remains in Xs. On a short-term scale this illustrates further the narrowing of market breadth, mirroring the long-term deterioration in breadth shown by the bullish percent indicators.

The High-Low Index for the NYSE remains negative at a high-risk level. The Nasdaq Composite High-Low Index remains in a column of Xs but declined again Friday, according to data from Investors Intelligence, putting it now within less than a quarter of a percent from a reversal down to Os.

Market Overview:
The S&P 500 Bullish Percent is negative and added another O on Friday, a negative divergence from the reversal up in the 50-day MA Indicator. The bullish percent indicator for the NDX remains negative and declined significantly again Friday.

The Bullish Percent for the NYSE and Nasdaq Composite remain positive, but had large down days on Friday and continue to show the longer-term pattern of diminished participation and lower highs dating back to their 2003 and 2004 peaks.

Charts of Interest:
Analysts and industry watchers continue to pound the table on Oil and Oil Service stocks. Admittedly, it's hard to leave a winner behind. Relative Strength in this group, by any measure, will remain strong for a long time as the outperformance of this group is monstrous compared to the S&P 500 and all but the precious metals, homebuilding and other raw materials-based sectors.

The OSX/SPX ratio (I use a percent scale ratio of 6.5%) reversed up in favor of OSX on July 9, 2004. Of course, this ratio first reversed up from an extreme (the lowest level it had been since 1999) in October 2001 and has been trending higher ever since, but on a PnF basis, the July 2004 reversal was the most recent signal so for simplicity we will count from this one.

OSX vs. Others; 7/9/04 - Present
OSX + 86.5%
SPX + 13.9%
XAU + 50.9%
HGX + 42.7%
CR/Y + 21.6%

The problem with relative strength as a stand-alone tool is that relative returns are not the same as absolute returns. Obviously. If I lose 10% in the OSX for example, but the SPX loses 11%, I will have banked relative strength, but at the expense of those 10% missing of my dollars.

One of the most dangerous situations an investor and trader will find is when relative strength outperformance reaches an extreme, but the underlying in the group begins to break down technically. Nothing lasts forever. Cycles change. When outperformance reaches an extreme and begins to break down, the absolute losses can be devastating (that is one risk), or the give-up in absolute returns versus another vehicle can translate into lost opportunity.

The OSX/SPX ratio is now at its most extreme since October 1997, using data going back to December 1996. This ratio quickly came back in line after reaching the October 1997 extreme. The reversal down in the OSX/SPX ratio on a PnF basis, indicating a potential conclusion to the outperformance cycle, occurred on Dec. 1, 1997. That initial leg down stopped on Sep. 11, 1998 with a reversal back to Xs. This is an illustration of how dangerous it is to pursue winners at the end of their cycle. Here are the performance figures after the PnF ratio charted the reversal down, giving us plenty of time to adjust our allocations or weightings:

OSX vs. Others; 12/1/97 - 9/11/98
OSX - 42.5%
SPX + 3.5%
DJIA - 2.7%
Nasdaq +0.7%

As if that were not bad enough. Suppose one decided, "Hey, Oil and Oil Service stocks have at this point, 9/11/1998, come in enough and the sell-off is a buying opportunity."

Oops. From 9/11/98 to the first reversal up after a new low in the OSX/SPX ratio, on March 17,1999, the absolute performance indeed returned to the OSX (whew) but the relative performance, sadly, did not:

OSX vs. Others; 9/11/98 - 3/17/99
OSX +1.4%
SPX +28.6%
DJIA +26.7%
Nasdaq +47.9%

Back to today
Today, we have the OSX/SPX ratio stretched to its most extreme since the 1997 period. Of immediate concern is that we have weekly DeMark TD-Sequential "sell" signals occurring with Point and Figure breakdowns in many of the stocks as the OSX/SPX ratio deteriorates.

The ratio has not reversed down on a PnF basis... yet. But the extent to which it is now stretched combined with significant high-risk DeMark signals on long-term weekly charts, and the high risk position for the PnF indicators in the market as a whole, suggests those pounding the table for energy stocks here may very well have another table pounding opportunity down the road... from still lower prices.

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No positions in stocks mentioned.

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