I’m a big fan of looking for intermarket relationship disconnects. Numerous academic studies show that there is a gradual diffusion of information that occurs within and across various sectors and asset classes.
In non-nerd speak, this means that there are delays one can spot and position portfolios accordingly.
I believe that there is a message now occurring within the iShares Dow Jones U.S. Oil Equipment (NYSEArca: IEZ), which suggests the possibility of a significant decline in oil prices ahead.
Take a look below at the price ratio of IEZ relative to the SPDR Dow Jones Industrial Average ETF (NYSEArca: DIA). As a reminder, a rising price ratio means the numerator/IEZ is outperforming (up more/down less) the denominator/DIA. The opposite is also true, whereby a declining price ratio means the numerator is underpeforming the market. Think of this as a way of neutralizing the “beta” component of sector movement.
One of the most important factors for investors in the oil equipment industry within the energy sector is expectations of future oil prices. After all, the higher the price of oil gets in the future, the more likely companies within this industry will see a pickup in contract activity and revenue growth. In early 2008, the ratio rose substantially anticipating oil prices rising (which they did to $147 a barrel). The ratio then fell off substantially in the latter part of the year as oil collapsed.
The main thing I want to stress is that the price ratio has failed to take out former highs hit in mid-March of this year, and the ratio has trended lower in a substantial way since late-July. Should the trend continue, oil prices may soon adjust to much lower prices ahead than one might otherwise anticipate. Given what appears to be a global slowdown and possible recession, this should not sound that far-fetched.
The author, Pension Partners, LLC, and/or its clients may hold positions in securities mentioned in this article at time of writing. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities.