by Kevin Klombies, Senior Analyst, TraderPlanet.com

The markets appear to be calming down somewhat as we push through towards the end of October. With this in mind we thought we would shift to something a new topic today.

Below is a chart of oil refiner Valero (VLO) from July of 2006 through May of 2007. Below right is a chart of Canadian natural gas producer Duvernay (DDV on Toronto) from July of 2007 through May of 2008. On a side note Duvernay was purchased by Royal Dutch Shell in July. With the stock trading around 58 RDS bid close to 83… which, we will argue, was an amazingly poorly timed take over.

Today’s argument has almost nothing to do with either Valero or Duvernay. The focus is not on the individual companies but rather on the way the markets tend to shift rather dramatically from theme to theme early in a new quarter.

Valero opened 2007 to the down side but by mid-January the stock price began to rise. Around the start of February the stock had pushed up high enough to move back above the 200-day e.m.a. line. From there the trend remained solidly positive through the second quarter of the year.

Duvernay opened 2008 weak after trending lower through the second half of 2007. The stock bottomed out in January and then pivoted back to the upside before pushing above the 200-day e.m.a. line around the start of February. Between January and July Duvernay’s share price rose from well below 30 all the way through 80.

Our point is that through the first few weeks of January in 2007 it would have been difficult to have known that the dominant trend would be related to a shortage of gasoline and, perhaps, equally difficult in 2008 to have known that the trend would favor natural gas and coal stocks. The chart detail that we are attempting to focus on has to do not only with the way these stocks opened the new quarter weaker but also how they pivoted upwards and pushed through their moving average lines around the end of January.

As we dig deeper through the month of October our thought is that relative strength should begin to sort itself out over the next week or so as the strongest stocks representing the next dominant theme pivot and pop back above their 200-day moving average lines. The challenge is not to look for bargains but rather to chase strength as it emerges into early November.

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Equity/Bond Markets

The above argument was, in fact, that over the past few years the dominant trend has had something to do with energy prices. The trend has favored the energy sector at times (usually through the first six months of the year) and the non-energy sector at other times (often the final six months of the year). Our goal at present is to try to ‘catch’ the next trend as it emerges out of the gloom later this month although we suspect that if it is based on rising oil prices we are going to spend the next few months arguing against it.

At right is a comparative view of AMR, Citigroup (C), and Barrick (ABX).

We do not know what the next trend will be but the argument is that it should start with a sector that has been negative for many months with stock prices some distance below the 200-day e.m.a. line. Through late October the stock price should pivot upwards through the moving average line before pushing higher for the next few months. The trend could favor the airlines (AMR) on weaker energy prices, the financials (C) on renewed optimism with regard to global credit conditions, or, we suppose, even the golds (ABX).

The trend could also shift back to the tech sector if the enormous piles of liquidity added to the financial system lead to a 1999-style recovery. We show Qualcomm and Nippon Tel below.

At bottom right we show Mitsubishi UFJ (MTU) and the gold etf (GLD) along with 3-month euribor futures. The idea is that the ECB meets this week to decide on interest rates and rising euribor prices should go with a recovery by the financials (MTU) relative to gold prices (GLD).

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