Monday, February 27, 2006

A New Look at Weak Energy Stocks and the S&P 500

For those who have requested the link, here is the article on first hour patterns in trading.

The relationship between the energy sector and the broad market indexes is a bit complicated. On one hand, you'd expect falling energy prices to benefit the economy and stocks. On the other hand, energy issues are well weighted within the major averages. For instance, since March, 2003 (N = 746), I find the correlation between the S&P 500 Index (SPY) and the energy ETF (XLE) to be .42. While this is significantly positive, it is lower than the correlations we see between many sectors and SPY.

We currently have an interesting situation in which SPY is up over the last four days by a little over three quarters of a percent, but XLE is down about 2.5%. Because such a move in different directions is relatively rare, I decided to take a historical look at what typically happens afterward.

Since March, 2003 (N = 746), we have had 111 occasions in which XLE has been down by more than 2% over a four-day period. Over the next four days, SPY has averaged a gain of .53% (72 up, 39 down). This is considerably stronger than the average four-day gain of .20% (359 up, 276 down) for the remainder of the sample.

Even more strikingly, we've had 32 days in which XLE has been down by 2% or more and SPY has been up over that period. Four days later, the average gain in SPY has been .83% (22 up, 11 down). This strength carries over to eight days out, with SPY up by an average 1.62% (27 up, 6 down). That is quite an edge.

It thus appears that strength in the S&P at a time of falling energy stock prices is bullish 1-2 weeks out. We'll count this one for the bulls going forward.