August 21, 2008 at 11:30 AM EDT
Headwinds Index Turns Up
Unless you are Usain Bolt, you are not likely to be in top form – not to mention setting world records – running into a headwind. For that reason, last month I developed something I call the Headwinds Index to calibrate the extent to which oil prices and concerns about financial institutions are providing a drag on stock prices.

In keeping with my desire for simplicity wherever possible, the Headwinds Index is calculated as the price of crude oil divided by the financial sector ETF (XLF). For various reasons, I used the USO crude oil ETF instead of the crude oil front month futures.

The resulting ratio chart, which I have enhanced from the previous iteration presented in Headwinds Index: How Long Can Financials Outperform Energy? now includes a 100 day simple moving average for the USO:XLF ratio and a 50 day SMA for the SPX mini-graph at the top. [I have also inverted the ratio to better align with the headwinds metaphor.] Note that the 100 day SMA served as support for the Headwinds Index last week and the current level is at the 50 day SMA, which is a potential area of resistance. If this index breaks above 5.0, I would expect to see a rush to re-implement many of those long oil and short financials momentum trades.

Finally, note that an upturn in the Headwinds Index has preceded a turnaround in a rising SPX on a number of occasions. Keep an eye on this divergence going forward, as I do not expect to see a sustained rally in the S&P 500 until financials are able to outperform energy on a relative basis.

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