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Stocks poised for a big correction: Yamada

Talking Numbers

Legendary technical analyst Louise Yamada says there could be trouble ahead for the energy sector and for the rest of the stock market, too.

While 2013 will be remembered as a great year for equities in general, one group of stocks underperformed the market: the energy sector.

However, there may be some more bad news ahead not only for the energy sector but for the rest of the market, according to legendary technical analyst Louise Yamada, Managing Director of Louise Yamada Technical Research Advisors.

While the market benchmark S&P 500 index gained 29% last year, the S&P 500 Energy Sector index only saw gains of about 22%. And, from the beginning of 2012 to the end of 2013, the Energy Sector returned 24% while the S&P 500 gained 46%.

(Read:  US oil ends at 8 month low; supply, demand factors weigh)

Yamada says the technicals on the Energy Sector are pointing to continued underperformance. She not only charts the S&P 500 Energy Sector index but also that index relative to the broader S&P 500.

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S&P 500 Energy Sector versus S&P 500 Index. Source: Louise Yamada

Yamada explains her chart this way: "The top line is the price of the Energy Sector and the bottom line is the relative ratio, the relative strength to the S&P 500 for the Energy Sector. When the bottom line is rising, the sector is either outperforming the market by going up more or outperforming by going down less. When the bottom line is falling – as you can see it's been doing for several years – the sector is underperforming the market. That would be going up less when the market is rising or possibly going down more when the market is falling. What we have here is really a negative divergence in the sense that prices have been climbing over the past several years, but the relative strength has been deteriorating."

Yamada says the support level in the relative value of the energy versus the market as a whole has been broken. "That's a six-year support that has been violated, suggesting that only could it continue to underperform by going up less but they've now entered the risk of possibly seeing the prices come down," says Yamada.

(See: CNBC's Energy coverage)

For the overall market, Yamada is also wary given recent technicals. She notes that the market's first five days saw declines. About half the time the market was down in the first five days of January, the markets closed the rest of the year down. Yamada also sees other headwinds for equities this year.

"We have the midterm elections," says Yamada. "You've got the four-year cycle low due in 2014. I think it's going to be a little bit bumpy and we'll keep our eyes out for a re-emergence of negative divergences that could take place over the next quarter if more stocks go sideways and start breaking support. I think that's what you need to watch for."

To find out what levels Yamada sees coming up for the Dow Jones Industrial Average and the S&P 500, watch the video above.

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