INVESTING: Energy, material stocks showing signs of strength

We’ve been talking lately about falling prices and the effects on stock prices. I know everyone gets a big kick out of cheaper gas, and a lot of experts are telling us oil will fall to $40 a barrel. But judging from recent market action, oil and other commodity plays might do better than observers think for the rest of the year.

The headline-grabbing news of the weak housing market is doing a great job taking people’s eyes off the quietly developing strength in energy and material stocks. Even if oil is stuck in a long-term trading range of $55 to $75 a barrel, when the price drops as it has recently, traders are going to be buying energy stocks. And that is exactly what seems to be happening.

Two perfect examples are easily illustrated by looking at the positive divergence between the price of oil and many of the stocks in the industry.

Oil dropped to near a 12-month low in recent days, and stocks in the sector, as measured by the exchange-traded OIH and XLE (I have a position in XLE), are trading comfortably above last month’s lows. This suggests that smart money sees higher oil prices soon, at least for the short term. And that’s exactly what this trade is: taking advantage of short-term momentum that is building under the radar.

Similar action is occurring in the basicmaterial sector. These are companies in businesses like paper, mining and chemicals. Not a lot of hype here, but these stocks can move quickly when they decide to go. The easiest way to watch this area is through the exchange-traded fund XLB (I have a position in XLB).

While the market is providing a constructive environment for upside action for at least the rest of this year, both energy and materials are poised to be good shorter-term trades. If oil moves above $65 a barrel before the end of the year, I would sell my energy holdings. If XLB moves from $33.50 to above $35, I’ll sell. I guess that says global growth is intact; it’s just not as robust as it was the last few years.

I am coming up to my five-year anniversary of writing this column. Since starting, I have received consistent feedback from readers.

I take pride in getting the big picture right and knowing how and when to stay out of trouble. I missed the bull market bottom in early 2003, but then got bullish by August of that year and pretty much stayed that way until this past January.

I remember seeing the S&P 500 at 1,295 on Jan. 11 and advising people to go to cash. That was clearly the right call for the first half of the year, as the S&P fell to 1,220 by June.

I am surprised at the lack of feedback about my not turning bullish in July. It’s true that I kept my negative outlook until getting back into the market in late September.

But a cold analysis of my actions produces surprising results. By late September, the S&P was at 1,330. I missed 35 points, or 2.7 percent. However, I made 2 percent sitting in cash. The 0.7-well, think of it as an insurance premium. Now that the storm clouds have passed, we can put away our umbrellas and take more risk.