We saw a pretty significant signal recently from the oil sector.   A relative strength sell signal.

This does not mean oil immediately becomes a terrible place to have money at work in March or April 2010.

But longer term, it suggests oil will (likely) under-perform the overall markets.  And, it's possible the sector could significantly under-perform.

This is really important, in more than one way.

First, let me walk you through another example where a sector gave a relative strength sell signal. The Financial sector gave a relative strength sell signal in April 2007.  Think about that.  That signal came before any of the mortgage stocks melted, well before Bear Stearns imploded (like nearly a year before that event) and significantly (18 months) before Lehman Brothers collapsed. And long before things like "sub-prime mortgages" and "TARP" became household terms.

And since "financial companies" were the largest component of the S&P 500 (at the time), it was a pretty serious signal for the whole market.

What was even MORE significant was that April 2007 was the first time that chart had flashed a relative strength sell signal…period.

Sure, some financial stocks rallied – and were even good trades AFTER the relative strength sell signal in April 2007.  But those gains were fleeting, and most were only short term trades.   You were trying to swim upstream in downward environment.

What relative strength charts can tell us is which areas will out-perform (or under-perform) their peers (or the whole market). And relative strength signals tend to last (on average) about two years.

Relative strength is not a trading tool.

So, oil, as a sector, has now given a relative strength sell signal. This is important because as the market has improved over the past year we've seen some common characteristics: as oil prices climbed, the dollar fell.  Are these two actions mutually exclusive?  Probably not.  However, in some ways, in the last twelve months oil became a proxy for inflation – and for the markets overall.  We saw areas rich in natural resources (like Latin America) perform really well over the past 12 months.

And now, in the last few weeks, we've seen the dollar strengthen (somewhat), we've seen emerging markets slow down (again, somewhat) and the price per barrel of oil has leveled off around the high 70's-low 80's area.

This does not imply oil will collapse with absolute certainty.  After all, the market generally looks pretty virile.  It also does not mean we will absolutely see Lehman-style collapses in the area either.  But never say never.

This is the first relative strength sell signal the oil sector has given, dating all the way back into the 1990's.

This is one big reason why I have stopped buying in the oil patch and the emerging markets.  These areas were "hot to trot" a year ago.   Now, I am more skeptical about investing in these areas. Too many times, investors will look at "what did the best last year" and blindly stick their 401k money there, or invest in the hot mutual fund of 2009.  Last year's superstars may become this year's (or next year's) duds.

Be careful!  Again, this signal could foreshadow conditions that may not appear for a few months, or even a year.  Or not at all. The sector could just stall.  But I'd rather be early, than a minute late.

Recently, oil and commodities dropped 20 to 25% in four very fast weeks, catching nearly everyone off guard. But as fast as the drop took place, we start to see signs of a reversal back up. These sharp violent corrections often take place in long sustained bullish advances.

What do you do if you are still holding commodities like oil, natural gas, heating oil, grains and agriculture? I'd encourage you to read on. If you don't have a longer-term view, then simply understand this: everything reverts to the mean.

Let me ask you a question…have you ever seen a bell curve?

Here's an example of a bell curve: suppose there are 20 students in a class.
When test-time rolls around, here were the scores in the class:

1 student scored 100
3 students scored in the 90s
12 students scored between 75 and 85.
3 students scored in the low 70s
1 student scored 60


Roughly 60% of the class scored between 75 and 85.
One student of the 20 (5%) scored extremely well (she got 100%).
One student of the 20 (5%) scored very poorly (she got 60%).

Statistically, there's a very good chance that the one student who scored extremely well may not get 100% the next time around. Additionally, the one student who scored very poorly stands a good chance of improving her score in the future. This brings these two extreme results back to the middle of the pack.

The reason why I went through this exercise was to show you that frequently results "gravitate toward the mean." In this case, the mean test score was somewhere between 75 and 85. In fact, 60% of the class fell in that range.

Let's apply this towards your investments.

Two thirds of the time (67%), investments will hang around the midpoint of the range — the middle of the 10 week moving average.

There will be times when your investment scores in the top 5% — this is a situation where your investment is clearly "over-bought." There are also times when your investment will score in the bottom 5%. This is when we say your investment is "over-sold."

The reason why I frequently mention the term "weekly momentum" is because you will see (in a chart) certain times when your investment may get extremely over-bought, or extremely over-sold. This period is usually followed by a time where your investment will revert to the mean.

Knowing these types of patterns and behaviors exist, prevent us from panicking and getting out at the bottom — and likewise, making a rash decision and buying something at the very top. It doesn't always work perfectly, but we do our best to "stack the odds" in our favor.

Maybe it's me, but it just seemed like a funny coincidence that as soon as the media started to talk about oil going to $100 per barrel, we saw a bounce (in two days) from $111 a barrel…up to $122 a barrel.

Exxon reported nearly $12 billion in profits for the previous quarter recently. $12 billion! More net profits in one quarter, than ever recorded in the history of mankind.

And what did the stock do?

It went down.

Numbers like $12 billion generate emotional responses: anger, jealousy, envy, and even pride. The media does a good job of stirring the pot. Once the emotion subsides, a lot of people start to realize that Exxon is one of the largest employers in the United States, along with being one of the biggest taxpayers in the United States as well.

But there was something in the earnings report that really got my attention — maybe you saw it, too.

In addition to reporting record earnings, Exxon also reported their total production declined. Companies like Exxon simply don't have the tools in place — or even available — to do more drilling or exploration. They simply don't have the infrastructure to increase production.

Now let's talk about their stock. And a short lesson in relative strength!

When compared to other oil stocks (Exxon's peer group), Exxon stock has been on a relative strength sell signal since 2001. While this member of the Dow Jones has done well compared to the S&P 500 and the other Dow Jones stocks, Exxon appears to be a weak-kneed Willie getting sand kicked on it by some of the other bruisers in the sector.

And now that Exxon has broken the support line, and the sector is falling out of favor…well, it's really starting to lead the parade out of town.

I suppose $12 billion just doesn't get you what it used to anymore, does it? This company is posting record earnings, record revenues, record profits… and the stock goes down.

Oh…one more thing. Can you guess what stock you will find listed as the first or second largest position (investments) in most large-cap growth mutual funds? Here's a hint…it used to be called Standard Oil.

Go ahead and read the headlines — just don't base your entire investment decision on headlines… like most people do.

Nearly 20 years ago, when I worked in Chicago, I became friends with a gentleman named Joe Lopresti. Today, Joe is the President of Arlington Capital Management. We've remained in touch and share our thoughts and outlooks on the market periodically.

Joe recently put together some extremely compelling — and well written article why investors ought to consider taking a look at oil stocks at the present time. Here are just a few of his thoughts:

Joe pointed out four specific oil stocks that have recently reported some pretty impressive numbers. The earnings for these four stocks were up 45%, 69%, 136% and 178% over the same period last year.

More importantly, all four of these companies are seeing their earnings grow at rates that are multiples (yes, multiples!) of the growth rate of the typical S&P 500 stock.

And yet these four companies all trade at a PE ratio that is at or below the average S&P 500 stock.

Now, here's the rub: over the last 60 days these four stocks (along with the entire sector), are down an average of 35% in price.

Some of you may be thinking… "sure, but if oil is dropping, won't the earnings for all the oil stocks also drop?" That is quite possible, but bear in mind that while oil has dropped — it is only back to the same price is we saw just three months ago.

Question: how many people do you know have quit their day job to start day-trading oil futures? And how many reality-TV shows can you find today discussing how much money you can make speculating in oil?

Not many. But yet, when Internet and technology stocks exploded a few years ago, people quit their day job to day trade stocks. And I've lost count of all of the "flip this house" television shows launched in the last few years.

We are nowhere near "an oil bubble" as the media would tell you… or wants you to believe.

Another point Joe made: a true sign of a bubble is when Wall Street cranks out IPO after IPO… and each new company has worse fundamentals than the previous one. Remember pets.com? When Internet companies were going public, there were no revenues, no earnings, no profits… many companies had no sales! There are very few (if any) oil companies going public at the present time.

This is no bubble.

One final point that Joe makes to quash the "bubble" theory: there are plenty of stories suggesting that "speculators" are behind the massive rise in oil and oil futures. The folks spinning these rumors are neglecting one important fact: when oil futures contracts expires, someone has to take delivery of the physical product.

What port do you want your barrels delivered to?

I agree with Joe: some of these companies will make spectacular investments. I do not believe, however, that today is the day and we want to step up and buy these things. I'd rather wait for the relative strength to improve and to see some buy signals before committing money.

What are your thoughts on the recent drop in oil?

Is this a buying opportunity…or the end of a bubble?

We don't make predictions at Mullooly Asset Management. And we rarely hold anyone else's predictions as credible. So keep that in mind with this post.

With oil recently trading over $140 a barrel, there is an article from the New York Times — that I think has been circulated all over the Internet — but everyone ought to read NOW, because of the topic.

Keep in mind, this article was originally published on October 14, 2001… just barely a month after September 11.

This was taken from statements from bin Laden, made originally 10 years ago…1998.

The last paragraph of the article reminds readers that in 1981, during the Iran Iraq war oil prices reached $40 a barrel. By 1986 oil had dropped to $12 a barrel. In fact, when the original quote was made (in 1998), oil was trading at $11/barrel.

Focus on the third paragraph — where Osama bin Laden, in 1998, tells the world the price where oil ought to trade at. Pretty amazing.

Don't get me wrong. This dirtbag is a detestable person who must be captured and appropriately punished for his actions. But I am sharing this link to show the deep motivation behind his actions. And also to show the uncanny price action in oil prices.

 Looking at relative strength changes really helps to drive home underlying themes in the market. As I have been saying for several weeks, there are only a few sectors that have been going up — most sectors have been just treading water — and some sectors are completely falling apart.

Here are some recent relative strength changes, you tell me if you can spot the underlying themes: New relative strength buy signals: Dominion Resources, Cross Timbers, Cal Dive International, Natural Gas and Worthington Industries (a steel stock).
New relative strength sell signals: Bank of America, more local and regional banks (too many to list), Enstar and Fortis (insurance companies), Black & Decker and Pier One Imports.

Remember that relative strength signals tend to last approximately two years (some longer, some shorter). By the look of things, I think this may be round two for the financial stocks (banks, brokers, insurance companies). And it doesn't look like oil and other commodities are done yet either.

Alaska Governor Sarah Palin is the youngest governor in Alaskan history — and — the first woman governor of Alaska. Palin was recently interviewed by Larry Kudlow, who is a terrific economist. Larry hosts a radio show on Saturday mornings in New York on WABC ("The Larry Kudlow Radio show"). I have called in and spoken with Larry on several occasions.

During the interview, Palin and Kudlow spend time talking about how to relieve the enormous demand for oil here in the United States by tapping the reserves found in the Arctic Natural Wildlife Reserve also known as ANWR.

Did you know that the area in question in ANWR is roughly 2000 acres — about the size of LAX (Los Angeles International Airport)? This is the area that is located just east of Prudhoe Bay in Alaska's North Slope…which happens to be North America's largest oil field and accounts for nearly 17% of all US oil production.

One of the big hurdles is it will take five years to get oil from that area to your corner gas station. It's a shame so much time is being wasted — we are all paying the price now at the pump. In her interview, Paling claims there are billions of barrels of oil and trillions of cubic feet of natural gas sitting there waiting for us to use.

Click here to read the interview. I think you'll enjoy it.

Have you seen the Bruce Willis movie, "Die Hard"?

When the police officer starts to drive away, Willis sends him a message…throwing one of the bad guys on the hood of the car.

And Willis yells "Welcome to the party, pal!"

Well, the stock market screamed that to Ben Bernanke this week.

On Tuesday Bernanke seemd optimistic things might improve later this year. But he also mentioned that the falling dollar has contributed to an "unwelcome rise" in inflation.

No kidding.

I wonder how much of the rise in gold, silver, oil and other commodities the past 12 months is directly because of the falling value of the US Dollar?

What do you think?

So…it seems Bernanke may be putting the pieces in place for an eventual rise in rates — possibly later this year or early next year — if, as he said this week, "inflation were to flash signs of getting dangerously out of hand."

Wait.
Did he say "dangerously out of hand?"
Let's see…oil has gone from $30 to $130.
Gold has gone from $300 to $1000.

Huh?

Oh…welcome to the party. Pal.

The market averages seem to be starting summer early. We saw a broad-based sell-off this past week, after several weeks of positive movement. For now, this looks more like a pause (a breather) than the beginning of something substantial. Our signals are still flashing offense, so the upcoming few weeks may prove to be a good opportunity to put some additional cash to work in the market.

Many of the areas that have been working, like steel, commodities, and some pockets of the energy sector are pausing. Some areas are starting real pullbacks. Once these pullbacks unfold, we may see another opportunity in the energy and commodity sector. The point and figure charts I use still indicate that oil could head as high as the mid-$150/barrel range, so any serious pullback may be another good opportunity.

Of course, when conditions change, we will change. Stay tuned.

The US government has been subsidizing the research, development
and use of ethanol.  This is being done in an effort to provide an
alternative solution to importing costly oil and gas for use here
in the United States. 

Some day, ethanol might be a great alternative.  However, it is
having a "ripple effect" in the economy.  This is from the Daily
Herald, a paper in suburban Chicago, on March 11, 2007:

     The Department of Agriculture said recently that strong
     demand for corn from ethanol plants is driving up the
     cost of livestock and will raise prices for beef, pork
     and chicken.  Meat and poultry production will fall as
     producers face higher feed costs, the department said in
     its monthly crop report.

     Ethanol fuel, which is blended with gasoline, is consuming
     20% of last year's corn crop, and is expected to gobble
     up more than 25% of this year's crop.

     The price of corn, the main feed for livestock, has driven
     the cost of feeding chickens, up 40%, according to the
     National Chicken Council.  The council says that chicken,
     the most popular meat with consumers, will soon cost more
     at the grocery store.  The industry worries the competition
     from ethanol could cause a shortage of corn.

     The average price of corn, unchanged from last month, is
     $3.20 per bushel, up from $2 per bushel last year.

That is a 60% increase in the price of corn in one year. 
This is Economics 101.  There is far too much demand for corn.

P.S. You would think that the corn charts would be skyrocketing.
But they have already made a significant move.  However there
are other areas where this news can possibly put money in your pocket.

P.P.S  There have been more reports over the past few days that
the "plantings" for corn are up tremendously, compared to last year. 
Sounds nice, but it's not what you plant, it's what you grow
(and ultimately harvest) that really matters.  A few dry weeks
(no rain) in late June-early July could do a LOT of damage.  

Tom

Thomas Mullooly
Mullooly Asset Management LLC
Our Only Business Is Fee-Only Investment Advice
www.mullooly.net
support@mullooly.net

As I am writing this, the Dow Jones is down nearly 180 points.

Sounds like a lot, right? That's about 1.5%

By comparison, October 19, 1987 the market dropped 22% in one day.

Perspective does matter.

 

Anyway, the last few days, I've seen headlines like:

- Greenspan Thinks U.S. Heading Toward Recession

- High-Risk Lending Companies Wiped Out?

- Stock Market "Priced To Perfection"

- Bomb Goes Off When VP Cheney Visits Overseas

- Oil Trading Up Again At $62 Today

- Lousy Durable Goods Orders Today

- China Stock Market Sells Off Big (8.8%) Overnight

 

Look, pick your poison. Doesn't matter which headline above floats your boat, the market is down. For the day…not forever.

 

The indicators I use to manage the risk in your account tell me this market is still on offense. This *might* be the beginning of a move down…or it could be a day to go fishing. Or shopping.

 

Nevertheless, when the indicators tell us to change, we'll change. We won't be the last guy left at the party.

 

Oil is heating up, precious metals are flying again.

 

If you have questions about anything we are holding, ASK.

 

Stay Tuned. It's getting interesting.

 

Do you know what a "trend change" is?  When a stock (or a mutual fund) has been above its' support line, it's in a positive (or upward) trend.

When that stock breaks the support line and starts moving down, you really don't want to own that anymore.  Because the general trend has changed – from something that has been trending up — to one that is now starting to move down.

But trend changes are subtle.  They don't happen overnight — or like a light switch. It's more like dimming the lights.  Before you know it, the room is almost dark.

Most people are either oblivious, or reluctant in admitting the situation is changing.  And this is where trouble (and the losses) begins for most investors.  They just have to be receptive to change.

 

Let's look at the energy sector.
In September we pointed out the following facts:

Crude Oil had just violated the support line going back to 2003 (when it broke through $68). This means that "supply" was now in control of Crude Oil.  The trend was heading lower.

Back then, the Oil Service sector registered a relative strength sell signal for the first time since 2004, after a 75% move up.

Many Oil and Oil Service stocks were breaking the support lines set back in March and June – even while the overall market was pushing higher. 

Look, "supply" continues to take more and more control of the energy sector. Crude Oil broke another important support level at $58 — and now just broke another at $53.  Also, more of the energy-related Exchange Traded Funds (ETFs) have given relative strength sell signals.

However, if you look at *only* the stock price — and not look at the charts, you'd find most of these energy-related names are trading right about where they were in September. 

The dimmer switch is slowing darkening the room for energy.  Hey, if you're not watching these subtle changes, the room will be dark.

And you won't even realize it.

 

Alexander Graham Bell said "When one door closes, another opens; but we often look so long and so regretfully upon the closed door that we do not see the one which has opened for us."

In the market, there are several areas for new investments. The offensive team remains on the field today.  Here are just a few:

• The Transportation Sector shows good relative position.  After a couple of months of consolidation from this group, it appears to be poised for another leg higher.

• Real Estate Investment Trusts (REIT's) have been a strong area for a number of years now.  The group continues to hold the number one position among all sectors.  You might be moving out of some energy stocks which provided dividends.  REITs should be a logical place to replace those dividends.

• A few pockets within technology continue to show strength. Specifically, Telecom and the Internet area (but not names like Ebay, Yahoo, and Amazon), are making moves now. 

More than ever, individual stock selection really matters.  The difference between the best performing and the worst performing groups continues to narrow. 

We mentioned previously that Sun Micro (SUNW) is a stock with some key technical breakouts worth looking into. 

There are more names like that we should be buying.  Let's book a time to talk about these specific stocks/ETF's.  Call Liza this week at (732) 223-9000. She can set up a 20 or 30 minute window for us to review and get your account pointed in the right direction.