A Contrary Pair Trade: Long Oil Service, Short Tech
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At the market lows in July, we featured a forecast from technical expert Richard Rhodes in which he took the very contrary position that "the one thing nobody expects" would be a market rally to new highs.
Now, two month later with the Dow in striking distance of that high, he takes a ever more contrary position � suggesting that risk-oriented traders should now consider a "pair trade" by going short the popular tech sector and long the out-of-favor oil services area.
�The Dow Industrials and S&P 500 appear poised to breakout above their old highs. However, our models have moved back to �neutral territory�, while several of our momentum indicators are overbought and turning lower.
"And, the advance/decline figures aren�t supporting a major breakout in the Dow and S&P 500 as they are not close to their previous May highs. Even if the Dow and S&P 500 do break to new highs...we suspect they will be sold, much in the way selling has taken hold of the NASDAQs and the Russell 2000 small caps.
"That said, we are becoming very interested in a 'long oil service shares and short technology shares' pairs position. The ratio of the Oil Service Index (OSX) to our proxy for technology � the NASDAQ 100 Index (NDX)�Quite clearly from a technical perspective � oil service is underperforming and has broken below its 140-day trading moving average.
"While this is bearish � it is only in so far as prices are now as oversold versus the 140-day moving average since November-2003. Moreover, our daily 20-day and 40-day indicators are trading at oversold levels for the ratio; thus the risk/reward on a long-term and short-term basis are rather good we would have to say.
"On a trading pairs basis, we are becoming more and more comfortable with the idea of owning oil service shares that have declined between -25% to -35% off their highs, whilst selling technology shares that have risen between +30% to +50% in the past 8-weeks.
"Historically speaking, when we look at a -20% decline in crude oil, we find energy shares drop on the order of -3%...not the major decline we have seen thus far. As for technology � technologyshares on average rise +7%...thus far they are nearly +20% higher off their lows.
"So...a bit of a divergence has occurred that we feel will reverse itself in the coming weeks and months. Indeed, the oil service/technology ratio was oversold relative to its trading moving average � the 140-dma. In fact, it is at its most oversold level since 2003. While this may not be the bottom, the probability suggests the trend is higher in the ratio and that declines such as this should be bought.
"Currently, we have no long positions via oil service shares. This changes today, for we are buyers of Baker-Hughes International (NYSE: BHI). We are also adding BJ Services (NYSE: BJS) from the long perspective. We are also comfortable putting on our long in Nabors (NYSE: NBR).
"At the same time, we are selling short Research in Motion (NASDAQ: RIMM) and SanDisk (NASDAQ: SNDK). These tech stocks are overbought and showing nearly identical negative patterns. We would remiss if we didn�t profit from what we have long seen as more of a short covering rally fueled by �performance anxiety�.
"However, this cuts two different ways as well given if stocks begin to decline as expected�then the overcrowded 'long technology' trade will become a source of funds...and we all know selling occurs faster than rallies."
Link: http://www.thestockadvisors.com/main-section/a-contrary-pair-trade-long-oil-service-short-tech.html
Now, two month later with the Dow in striking distance of that high, he takes a ever more contrary position � suggesting that risk-oriented traders should now consider a "pair trade" by going short the popular tech sector and long the out-of-favor oil services area.
�The Dow Industrials and S&P 500 appear poised to breakout above their old highs. However, our models have moved back to �neutral territory�, while several of our momentum indicators are overbought and turning lower.
"And, the advance/decline figures aren�t supporting a major breakout in the Dow and S&P 500 as they are not close to their previous May highs. Even if the Dow and S&P 500 do break to new highs...we suspect they will be sold, much in the way selling has taken hold of the NASDAQs and the Russell 2000 small caps.
"That said, we are becoming very interested in a 'long oil service shares and short technology shares' pairs position. The ratio of the Oil Service Index (OSX) to our proxy for technology � the NASDAQ 100 Index (NDX)�Quite clearly from a technical perspective � oil service is underperforming and has broken below its 140-day trading moving average.
"While this is bearish � it is only in so far as prices are now as oversold versus the 140-day moving average since November-2003. Moreover, our daily 20-day and 40-day indicators are trading at oversold levels for the ratio; thus the risk/reward on a long-term and short-term basis are rather good we would have to say.
"On a trading pairs basis, we are becoming more and more comfortable with the idea of owning oil service shares that have declined between -25% to -35% off their highs, whilst selling technology shares that have risen between +30% to +50% in the past 8-weeks.
"Historically speaking, when we look at a -20% decline in crude oil, we find energy shares drop on the order of -3%...not the major decline we have seen thus far. As for technology � technologyshares on average rise +7%...thus far they are nearly +20% higher off their lows.
"So...a bit of a divergence has occurred that we feel will reverse itself in the coming weeks and months. Indeed, the oil service/technology ratio was oversold relative to its trading moving average � the 140-dma. In fact, it is at its most oversold level since 2003. While this may not be the bottom, the probability suggests the trend is higher in the ratio and that declines such as this should be bought.
"Currently, we have no long positions via oil service shares. This changes today, for we are buyers of Baker-Hughes International (NYSE: BHI). We are also adding BJ Services (NYSE: BJS) from the long perspective. We are also comfortable putting on our long in Nabors (NYSE: NBR).
"At the same time, we are selling short Research in Motion (NASDAQ: RIMM) and SanDisk (NASDAQ: SNDK). These tech stocks are overbought and showing nearly identical negative patterns. We would remiss if we didn�t profit from what we have long seen as more of a short covering rally fueled by �performance anxiety�.
"However, this cuts two different ways as well given if stocks begin to decline as expected�then the overcrowded 'long technology' trade will become a source of funds...and we all know selling occurs faster than rallies."
Link: http://www.thestockadvisors.com/main-section/a-contrary-pair-trade-long-oil-service-short-tech.html
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