Oil and stock indexes (such as the TSX Composite) are gauges that can be used for picking individual stocks. Since certain stocks will perform better than these benchmarks and other stocks will perform worse, we want to find the ones which show the most promise. This is done by comparing the price action of individual stocks to oil and stock indexes.
Oil and stock indexes are highly correlated (move with each other) over the last decade. This was not always the case, pre-1999 oil and stock indexes had a very tenuous correlation, often moving inversely. By using both oil and stock indexes we can improve our chances of picking quality stocks.
What I like to see when oil and the TSX Comp are falling is an individual stock that has sold off, but is no longer dropping. If it is no longer falling as oil and overall stock market continue to fall it is a good sign. This phenomenon is known as "relative strength."
Here is a recent example: Canadian Energy Services (CEU.TO) has performed betterin percentage termsthan oil and the TSX Composite over the last year. Recently when the oil and stocks declined rapidly in early August, CEU.TO sold off as well. The interesting thing is that while the TSX and oil made new lows for the year, CEU.TO did not even make it to the low it saw in June.
Figure 3 shows this visually. CEU.TO is the green and red bars, oil is the purple line and the TSX is the yellow line.
Figure 3 shows an example of the type of action we are looking for. By finding stocks with similar patterns over the long-term, positions can be taken for when equities and oil begin to trend higher once again. That trend may be some months away as there exists the potential that stocks and oil continue to move lower over the next several months.
CEU.TO is a short-term example, but as the stock market and oil continue to decline (in my opinion) what are we looking for down the road? In the 2008 decline CPG.TO showed great strength as oil and the TSX Comp continually made new lows. Figure 4 shows CPG (red and green bars) versus TSX (yellow line) and Oil (purple line).
CPG made lows in early December of 2008 (circle labeled "1") and oil and stocks continued to decline into February and March respectively. The fact CPG would not go lower as these two benchmarks went lower was a signal to buy the stock.
Be afraid of stocks that have been hit and hard and continue to fall. Love stocks that have fallen and stopped falling as oil and the broader market continue to decline. This shows selling is exhausted and any positive news or push higher in oil prices, stocks or the sector will raise the price of the stock.
Disclosure: CEU is an OGIB stock and Keith Schaefer owns shares.