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Energy ETFs: Ride the Wave


As the US stock market entered into its fifth year of this bull market in March 2013, it is now trading at record highs and has climbed some 1000 points or 150% from its March 2009 low of 666.79.

It should be crystal clear that the easy money has been made.  As mentioned in the April Technical Guide to the S&P 500 ETF (SPY) , the stock market can still go higher, but it is likely that it is in the 8th/9th inning of a 9 inning ball game.

This means that equity markets might begin to diverge and sector rotation is going to be crucial in alpha generation and detecting a market top.

It appears that the Energy sector is going to be the next wave to catch.

Sector rotation into Energy (IYE) may be in the early stages

The chart below may prove to be the key to alpha generation in the weeks/months ahead.

Over the last four and a half years, there have been a number of times in which IYE shifted from an outperformer to an underperformer versus the S&P 500.  T

he orange arrows represent periods that IYE reached some kind of peak in outperformance and was followed by either sharp and rapid declines in relative strength or other prolonged and more painful periods of underperformance.  On the other hand, it is quite striking how IYE managed to find support almost exactly at the bottom of the trading range on four distinct times, leading to sustainable periods of outperformance.

The question now is whether or not history will repeat as IYE has found support again in April 2013.

A Technical breakout confirms an important low has been generated

Arguably, the longer-term relative strength chart above is quite compelling on its own merits.

However, this near-term chart adds valuable supportive technical evidence that IYE has begun a sustainable period of outperformance.  In other words, the breakout from the February 2013 downtrend line solidifies the April 2013 bottom and suggests that the outperformance may still be in its early stages.

From a sector rotation point of view, look towards the Energy sector as a way to achieve alpha in your portfolios.

Higher prices also seem to be in the cards

The iShares U.S. Energy ETF has recently broken out of a large two and a half year symmetrical triangle pattern.  This coupled with the relative strength breakout (shown above) suggests that IYE has become a technical leadership sector ETF within U.S. equities.  The technical breakout now opens the door for a move up towards the 2008 peak of 52.67.

In fact, the target derived from this breakout is closer to 60.  In order to protect profits and manage risk, initial support should correspond to breakout level near 45.60.  Secondary support corresponds to the April 2013 low (41.96).

J. Beck Investments is an independent provider of technical research for ETFs.