Horrifying Research Reveals Rally-Ready Market

It’s time again to peer into the darker corners of the equity market, where only the brazen and stout of heart dare to tread.

Please do follow along.

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We’re going to look at three distinct sectors of the market today in an attempt to build a composite picture of where things are headed over the near and intermediate term.

It’s an approach we’ve had good success with for a number of years. Perhaps, you’ll read on and gain something in the process.

Here we go…

Our first stop is the oil patch, where we often head to get a read on potential inflationary pressures. The rationale is – as goes the price of oil, so, too goes the cost of most goods and services.

Why?

Because oil price inflation is nearly always a function of a hot global economy. When factories are producing a-go-go and the increased production requires more fuel, and shippers are therefore more active, you can bet that consumers are also spending their money like nobody’s business.

To get a take on whether that’s happening, we’ve charted oil, as represented by the United States Oil Fund ETF (NYSE:USO), against the world’s largest producer, Exxon Mobil (NYSE:XOM).

We’ve charted a year’s worth of data, and the resulting pattern is very interesting.

Take a look –

usoxom515

XOM has led USO both up and down for the better part of a year now, and we believe the pattern is set to continue.

But before we continue, we understand that you may be thinking the pattern is just a coincidence, or that there are other factors that explain it, or that you can draw better patterns – some, even, that resemble a spaceship – and that’s your pejorative, brother. Believe as you like.

“Did he say ‘pejorative’?”

Yes, and furthermore, we contend that the oil company investor is as shrewd a devil as they come – able to eyeball the day-to-day wrangling of an Exxon Mobil against all the competitive forces that are swirling about her – including the price of crude – and buy or sell the stock accordingly.

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The stock’s prospects are therefore always a step ahead of the price of the commodity, pulling back as the company retrenches in expectation of a slide in crude, and becoming more expansive as a more aggressive corporate posture is assumed in the face of rising prices.

And what’s it saying now?

We see an XOM stock that’s just notched new all-time highs and whose technicals look every bit the bullish juggernaut. And remember, this is happening at a time when questions swirl over the status of a great many of the company’s assets in Russia and the Ukraine.

In short, we expect oil prices to follow XOM higher over the near term, accompanied by increased wage and price inflation and the chart above is but one of a number of proofs we lean upon to base that assumption.

>What About that Consumer…

We mentioned above our expectation that consumers will soon regain their proclivity for spending. And that’s borne out in another two-stock overlay that we’ve charted below.

It’s a paste-up of the Select Sector SPDR Consumer Discretionary ETF (NYSE:XLY) against its sister, the Select Sector SPDR Consumer Staples ETF (NYSE:XLP).

What you’re looking for here is the to-and-fro action of investors as risk and worry vie for the news headlines. That is, when folks are scared, they tend toward the staples (XLP), when they’re feeling more expansive, toward the discretionaries (XLY).

xlyxlp515

The green lines represent moments of confidence, when discretionaries pull away strongly from the staples. Conversely, the red lines are pockets of distress, when the gap between the two closes.

And what does it mean?

The see-saw action between the two leads us to believe that we’re now at a point of extreme worry. If we had to bet, we’d go contrary – long XLY and short XLP in a pairs trade, with the expectation that the gap will once again widen.

That should happen soon, as confidence begins to be renewed.

Indeed, it may already have started.

The Dow Jones Industrial Average and S&P 500 both hit new all-time highs earlier this week, at a time when general investor sentiment is very poor, as seen in the AAII numbers (not shown here), and as discerned from the chart above.

That kind of worry generally translates into imminent, big spikes upward in the indexes.

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A Golden Battle to the End

The result of a renewed move upward for stocks and a renascent urge to spend will bury gold. Gold was bought this last decade primarily by investors chasing alpha. And when that alpha apparently ran out, the chase moved to new arenas. And that’s where we’re positioned today. Gold is out. Stocks are in. The arena is still the equity market.

Have a look here –

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This is gold charted against silver for the last year. In the bottom right, you can see that silver just broke below five-month support (in red). It was a marginal breach, but a breach is a breach, so traders are likely ready to pull the trigger on any repeat move in that direction.

Gold, on the other hand has held above its two month lows at $122.90.

Will it continue to do so?

But only for as long as it takes the Dow to notch another high.

A day?

Two days?

A week?

You tell me.

Many happy returns,

Matt McAbby
Senior Analyst
Normandy Research

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