02/04/15   Oil Conundrum Continues

Editor’s Corner

Ron Rowland

We are on record with our belief the large drop in crude oil prices over the past seven months is not a sign of global economic weakness. Instead, it is the result of excess supply from the unprecedented surge in U.S. oil production. Granted, there may be a little of both at play here, but in our opinion, whatever amount of economic weakness you want to assume, it is not enough to cut the price of oil in half. Increasing supply, not dwindling demand, is the major cause.

In contrast to our theory that low energy prices should be beneficial to economic growth as a whole, analysts partially blamed falling crude oil prices for nearly every market pullback in recent months. We are aware that most companies in the energy sector are the exceptions to our theory, but the other 90% of the economy should benefit.

Crude oil prices rallied strongly the past week, to the tune of nearly 20% for some futures contracts. They are settling back today, but the massive short-term upward move caught the attention of traders and the news media. However, we are scratching our head once again because the jump in oil seemed to cause a rebound in the broad stock market too. The conundrum of oil prices and economic outlook continues.

Today, crude oil is once again headline news. After its spectacular run-up of the past week to $53 a barrel, it is backing off to below $49 today. Any other day, an 8% drop would be considered a plunge, but today it is merely a partial retracement of the recent jump. Adding to today’s action is the U.S. Energy Information Administration’s report that crude oil inventories rose by 6.3 million barrels this week. The report went on to say inventories are at their highest level since 1930. An 85-year high in stockpiles adds further evidence to our claim that low energy prices are an oversupply situation, not a lack of demand problem.

Investor Heat Map: 2/4/15


Many of the strongest market segments on an intermediate-term basis produced the weakest performances over the past week. Conversely, those with the most intermediate-term weakness put up great short-term bounces.  This type of action tends to compress our rankings, although it is not too noticeable in today’s EdgeChart. Whether this marks the start of a significant reversal and sector rotation or is just a countertrend bounce remains unclear.  Real Estate continues its stay at the top for a sixth week and shows no signs of relinquishing that position yet.  Utilities and Health Care hold down the second and third spots respectively, indicating investors are still taking a defensive approach.  Consumer Discretionary moved ahead of Consumer Staples as homebuilder stocks rallied strongly.  Telecom, Industrials, and Technology are lagging, although they are still able to post positive momentum scores.  Materials bounced strongly enough to move it out of the red, but it is not exactly in the green at this point. Financials lost more momentum and slipped into a slightly negative trend.  Energy had a fantastic week.  Unfortunately, it came after seven months of mostly dreadful performance, leaving Energy in last place.


Small Cap Growth grabbed the top spot a week ago and continues to occupy that position today.  The three Mid Cap categories congregated in the upper half with identical momentum scores last week.  They remain in a three-way tie again this week, and each moved a step higher in the rankings.  There is an odd combination of Small Cap Blend and Large Cap Growth sitting in the middle, but anything is possible when there is relatively tight compression in the rankings.  Micro Cap took a tumble, as it did not bounce as strongly as the rest of the market and fell from second to fifth place.  Large Cap Blend, Small Cap Value, and Large Cap Value all weakened while holding their relative positions.  Mega Cap is on the bottom for a seventh week and today slips into a slightly negative trend.


A significant shakeup in the global rankings occurred again this week on top of the dramatic shift highlighted in our previous update.  China has been immune to the ranking changes so far and is celebrating its ninth week at the top.  Europe is the big winner this week, jumping six places to grab second place, as stocks there react positively to the ECB’s quantitative easing plans.  Japan moved a step higher, and EAFE improved two positions at the expense of the United States.  Market volatility and short-term weakness in the U.S. dollar combined to move the U.S. two steps lower on the global ranking stage.  World Equity and the U.K. are in a tie for sixth.  Pacific ex-Japan moved from red to green and one notch higher in the rankings, as Australia broke free of its short-term trading range. Emerging Markets lost a small amount of momentum on weakness in Latin America, but this week it meant a plunge of seven places in the rankings.  Canada displaced Latin America at the bottom a week ago, but a rebound in the Energy sector and weakness in Brazil put Latin America back on the bottom.


The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.


“The question is, is this the bottom? It’s absolutely too soon to tell. It’s way too soon for crude-oil producers to pop the corks on their champagne bottles and celebrate dodging a bullet.”

Walter Zimmerman, Chief Technical Analyst at United-ICAP (2/3/15)


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