Benzinga - by David Cox, Benzinga Contributor.
As an investor, we need a process to compare alternative opportunities in effort to maximize the productivity of capital and seek the best risk-adjusted returns. Sure, time frame matters and some investors can be more patient than the next another, but concepts like relative strength, trend following and sector/industry market breadth can help.
With 11 sectors according to the Global Industry Classifications (GICs) standards, and within each of these sectors, that are often many more industry groups, that tend to be defined by niches of companies with which the broad brush would be too broad to call similar.
So let’s dig right in and use some of the tools of technical analysis to gain perspective and help us develop insight into a given industry group. Today, I’m going to start with oil services. Oil services is part of the energy sector, and the first thing I’d do is compare the oil services stocks to the broader energy (one of the 11 GICS sectors) itself.
In this 2-year daily chart, we can see that OIH (ARCA: OIH) recently broke above the early ’23 highs (green arrow). In the middle panel, you can see a higher highs/higher lows uptrend against the broad SPDR Energy $XLE (ARCA: XLE) sector that has provided +26% in relative performance over the past 12-months, meaning OIH has bettered the broad sector by as much. The bottom panel, shows a less consistent trend against the S&P 500, given energy has spent most of 2023 underperforming the index, but a similar +26% in relative performance (yes, your math is working – that means $XLE has performed in-line with the S&P 500 in the last 12-months).
After we’re satisfied of the relative strength of the industry group (are you?), we’re going to dig into the constituents and find out what’s driving the ETF and where the strength is coming from within. Any time we can find broad based participation, the opportunity should be considered more legitimate in my opinion. For example, if there are 20 stocks in the oil services ETF and only 1 of them was rising, that’s not nearly as promising as if we had 15-16 stocks of the group rising together. Why? The latter would demonstrate strong breadth and committed buying by institutions and we want to stand in the way of the big buyers, who don’t have the luxury of buying their shares on a single day, or even a week. Institutions leave a footprint with their investment ideas and strategies, and we can see what they’re doing if we follow price.
Here's the 8-largest stocks (by weighting) in the OIH ETF over the past three-months, including the ETF itself and the S&P 500 (so we can remember the concept of relative strength). The outlier, is the market itself, meaning these oil services stocks have been doing very well in recent months.
I see a fairly tight set of price patterns over the last few months, which means they’re moving together. Check. No real standouts and now one would be left to decide how to approach it. A point always worth remembering is that you can typically gain exposure with less volatility by buying the basket, or the ETF in this case. Less individual company risk, via diversification, can be expected to provide a smoother ride and in this situation without any clear leadership within, I’d say it makes sense to embrace the importance of this concept. Anytime we, as investors, can take an opportunity that offers a similar expected return with lower risk, this should be preferred.
David is a Senior Portfolio Manager at “Financially INsync” in Waterloo, Canada. If you are interested in his research and want to gain more insights, please follow him on X (formerly Twitter) at @DavidCoxRJ and email david.cox@raymondjames.ca to subscribe to his distribution list which includes a free weekly webinar called “Where Do We (Investors) Stand?”.
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