The current economic concerns notwithstanding, one has to look at Fed zero-percent rate policy and quantitative easing from the likes of Japan and Europe as tailwinds for broader equity gains. That said, it may be difficult for the value-oriented to pay 25x cyclically adjusted earnings for U.S. equities at all-time highs.
It follows that more reasonable valuations might be found in the energy patch. Sure, oil might drop from $80 to $75. It might even reach the low $70s. Yet the more likely outcome is for oil to stabilize, and that should be a huge boost for the beaten-down bargains in SPDR Select Energy (XLE).
Recently, I suggested that the overall health of the bull market will largely depend on value-oriented mutual funds as well as institutional dollars flowing into price-to-earnings bargains in the energy sector. The XLE:S&P 500 price ratio has not yet shown sustainable relative strength for energy stocks, though the last few days have been more promising.
In sum, the bull market in U.S. stocks can continue with the blessing of severe laggards like XLE. On the other hand, plummeting tech shares in proxies like PowerShares NASDAQ 100 (QQQ) eventually ushered in the 2000-2002 bear; the early downtrend in SPDR Select Financials (XLF) foreshadowed the 2008-2009 bear. Could XLE be the next harbinger?
In my estimation, oil will stabilize in the $75-$80 range, rather than free-fall towards $60. If I am wrong – if global deflation anxiety surpasses the stimulative efforts of central banks around the world – then the questionable global economy would turn recessionary. And if that happens, stocks would fall dramatically to reflect economic realities as well as investor psychology. (Read more about ETFs and the psychology of investing crowds here.)