Headwinds Index: How Long Can Financials Outperform Energy?

Two weeks ago, I introduced something I called the headwinds index, a simple ratio of financials (XLF) to oil (USO). It took another week for that index to bottom and the markets to rally, but since that bottom, financials have jumped 37% while crude oil has fallen 14% from its peak. The headwinds have turned into a strong tailwind, at least for the past six days.

The question, of course, is how long financials can continue to gain ground before a new long oil, short financials trade becomes too attractive to pass up. Several of my indicators suggest that the tailwinds are about to dissipate in the next day or two; after a strong opening, today’s developing gravestone doji also calls into question the staying power of the recent trend reversal.

At a minimum, I suspect the new tailwinds have gotten ahead of themselves. When they start to move back in the wrong direction, there is little reason to remain in the long financials, short oil trade past its useful life. As sailors are fond of saying, “tack on a header!”

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Comments

[Jake2:]

Looks to me like you might be missing one leg of the stool. I.e., Gold. Also, this PM lots of congressional action re: housing. Everything is connected . . .

2008 Jul 23 05:22 PM

[CLH:]

Its bye bye commodity bubble. These bubbles usually go down 75 - 80%. Hang on for the ride.

2008 Jul 23 06:26 PM

[simjos04:]

The problem with your analysis is that you forgot. External forces come into play are not accounted for as variables in your model. KEYS: 1, sec shorting rules 2, housing bill just passed. 3) Oil dropping as dollar strengthens. But go ahead and do what you recommend, sorry you have to lose money

2008 Jul 23 07:21 PM

[starkoski:]

Bill, you have nailed it in this article - bravo to you. The fed can print and mininipulate (PPT) all they want but they can't print oil, nat gas & coal. We are in a Peak Oil state of mind that is written in geology. The fact that they (Fed Reserve Mob) tried this financial treachery is scarry to think what they might try when the dollar is dumped by the world in the near future. Thanks again for your good article and keep them coming.

2008 Jul 23 09:08 PM

[surgcare:]

Who ever thinks its good investing to take your money out of commodities whose companies are making billions with positive future earnings and putting your money into financials whose companies are loosing billions and project continued loses ,needs serious mental therapy .

2008 Jul 23 09:56 PM

[objective:]

Could the regulators be saying, in effect:
"The hedge funds have to short something, lets give them something to short, lets make it impossible to short financials thru a rules change, and give them no other choice."
Hint: Take a look at the 1 year charts of commodities vs. financials and see which one looks like its time to sell.....we're only 2 weeks into it....

2008 Jul 23 11:02 PM

[Ames Tiedeman:]

Not long. The re-test of the lows has begun.

2008 Jul 29 07:16 AM