How to invest when trends zig and zag

By Jim Jubak

No matter whether you're a technical or fundamental investor, a short-term trader or a long-term buy-and-holder, a top-down Big Picture student or a bottom-up stock-picker, the Wall Street advice is the same: The trend is your friend.

But how do you go with the trend when the financial markets themselves are serving up contradictory trends? That's not a rhetorical question. Right now, the stock market's short-term and long-term trends are pointing in different directions. To compound an investor's difficulties, the intermediate-term trend -- through the end of 2007 -- is extremely uncertain.

All in all, I can't think of a recent stock market where the usually sound advice to follow the trend is so unhelpful. Let me try to "unmuddle" the muddle by laying the groundwork in today's column for strategies that will let you make the trend your friend even as the trend zigs and zags. In my next two columns, I'll give you specific stock picks for executing two of these strategies.

Energy and conflicting trends

To give you an idea of the dimensions of the conflicting trends problem, take a look at the energy sector. Oil prices have come down to $65 a barrel on Sept. 12 from $78 on July 13. That's the lowest level in five months. Falling oil prices have taken down share prices across the sector: Among integrated multinationals, ExxonMobil (XOM, news, msgs) shares are down 7% in the two weeks from Aug. 29 through Sept. 12. Among small producers, XTO Energy (XTO, news, msgs) is down 13%. Among "alternative producers," Canadian Natural Resources (CNQ, news, msgs) is down 15%.

And the damage hasn't been limited to oil producers: Oil-services giant Schlumberger (SLB, news, msgs) is down 14% in the same period. Or even to oil: Coal producer Peabody Energy (BTU, news, msgs) is down 21% and solar cell manufacturer Evergreen Solar (ESLR, news, msgs) is down 7%.

Looking in the rearview mirror, it's not hard to explain the drop. Geopolitical tensions have temporarily receded with diminished grandstanding from Venezuela's President Hugo Chavez and Russia's President Vladimir Putin, a lull in strike activity and militia violence in Nigeria, and a likely compromise, for a few months at least, over Iran's nuclear bomb program. Speculators have suddenly awakened from the spell cast by the enthusiasm of Wall Street analysts who in April were predicting a top for oil at $105 a barrel (Goldman Sachs) and in September a top of $250 a barrel (Standard & Poor's) and are taking their profits.

How about oil priced at $55 a barrel instead? There are several global trends pushing oil prices down right now:

• The end of the U.S. driving season and a mild (so far) hurricane season have helped push up world inventories.

• Demand at the margin is falling, according to the International Energy Agency, which on Sept. 12 dropped its forecast for demand growth in 2007 by 100,000 barrels a day to an increase of "just" 1.5 million barrels a day.

• At its Sept. 11 meeting, the Organization of Petroleum Exporting Countries (OPEC) agreed not to cut production quotas at this time.

• Increased supplies resulting from higher spending on improved production have expanded the margin of supply over demand to 3.4% from 2.3%.

All else being equal, which it never is for long in the oil markets, the balance of supply and demand argues for oil prices of about $55 a barrel, Deutsche Bank calculates.

Me? I've got my doubts that we'll see $55 a barrel again. The politics of the oil exporting countries are just too volatile for the current relative "peace" to last. Talks about the lack of security in the oil fields between the Nigerian government and oil industry unions, for example, broke down just a day before the unions were to start a three-day warning strike. The oil future's market agrees: The oil for December delivery was priced at $67 a barrel on Sept. 11, about $1.50 a barrel above that day's spot price for oil

But it is clear to me that the strong upward trend for oil prices and for the prices of oil stocks is broken. Phil Erlanger of Erlanger's Squeeze Play now ranks the sector last for technical strength of the 24 sectors he tracks. Stocks like ExxonMobil and Schlumberger have broken below key support at their 50-day and 200-day moving averages, respectively.

In the short term, between October and the end of the year, I can see a bounce in the prices of stocks in the energy sector if oil prices stabilize after their 17% plunge from a record $78.40 a barrel on July 13 to $65 on Sept. 12.

But in the intermediate term -- that is, out until the end of 2007 -- I find it hard to see a resumption of the rally in this sector until prices have muddled along at something like current levels for a while. The sector needs to build a base at these prices before it can begin another leg up. In the intermediate term, possibly as far out the end of 2007, the energy sector doesn't deserve to be over-weighted in my portfolio any longer.

Taking a longer view

Long term, however, the trend is totally different. The International Energy Agency sees oil demand growing by 1.6% annually over the next 25 years. That may not sound like much, but that 1.6% annual growth adds up to a 50% increase in world oil demand by 2030. Oil demand, which the agency projects at 92 million barrels a day by 2010, would hit 115 million barrels a day by 2030.

The International Energy Agency believes supply will grow to meet that demand -- if the world's oil producers can come up with $17 trillion to invest in energy production (in constant dollars) by 2030. That money is needed to find new oil, develop already discovered reserves, recover more oil from existing fields, and build new refineries, pipelines and storage tanks. If the capital isn't forthcoming, you can count on the price of oil going higher from today's nosebleed levels.

One thing I like about this trend for the long term is that if the International Energy Agency is right, investors in energy stocks will make a lot of money over the next 25 years.

And if the agency is wrong, investors will make even more money. For example, if global oil production has peaked or is about to peak, demand will outstrip supply no matter how much money oil producers throw at the problem. And you think you're angry at the size of oil company windfall profits now?

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