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Weekly Energy Equities Review, Market Outlook and Trading Plan for October 19-23

The XLE closed a little lower than where it started the week, but the price action was very encouraging. It seems like the sector is getting close to finding some solid demand and turning up for a trend back to the mid to upper 30’s. There’s a big level down at 29.75 and Thursday’s gap down open tested that level and buyers drove it straight back to close at the highs around 31. This 29.75-31.25 level is building and there are buyers accumulating here, and while I don’t think we have reached the absolute bottom yet for energy, the final shakeout could be coming soon. As for the SPY, it was also positive with another run at the all time highs. The retest of the 342.50 breakout point on Thursday was huge and I think that probably sets the stage for price to break the 359 level and then complete the journey to the 380-400 level somewhere around election time. But in the end, there’s probably an election results rally into December and then the whole thing comes down. It’s been a great run, but everything eventually ends. But don’t look at it as an end, just consider it a reset for the next great bull run.

 

SPY – The technicals are still healthy. Price retested the 342.50 breakout level as it should have and bounced nicely. I’ve seen a lot of “double top” predictions, but I just don’t think that’s happening. It’s possible that price might test the 342.50 level early on Monday, but then I think price recovers and makes a run at 354, 359 and then on to the final target. I would get concerned if 342.50 failed on the next test, as that might suggest to more traders that a double top is indeed in and encourage shorts to get active. The other important points this week for the SPY will be 349.50 and 354. Ideally, I’d like to see price test the 342.50 level before lunch Monday, then turn sharply and reclaim Friday’s 347 close in the afternoon, with a Monday close in the 347-349 area. That would likely setup a big gap up over 349 for Tuesday and then a run at 354 on Wednesday, followed by an attack of the all time highs later in the week. If for some reason the SPY did fail early in the week, 331 and 320 remain important levels on the downside.

 

QQQ – Many people still see tech as a pure risk-on asset, but I think there’s a big group of players who use tech as a safe haven to park big money when things get a little uncertain. The QQQ showed some relative strength and never dropped down far enough to retest the 281 breakout point. If the SPY comes down and retests 342.50, then the QQQ might make a run down to the 281-283 area, and that would probably make for a great entry long into the election. If things get uncertain around the election, money will flow to the mega cap tech stocks. If 281 fails, the next level down is 273, then the 260-265 area. It’s likely QQQ takes out the 304 highs this week but I have no idea where the final top will be, however it could be much higher than everyone thinks due to big money chasing safety, which then encourages retail to FOMO chase.

 

IWM – The small caps are the most important sector this coming week. They have lagged the SPY and QQQ and still haven’t broken to new all time highs like the SPY and QQQ did. If the IWM can break the 164 level, that likely leads to a test of 170 for a possible breakout above 173. If price takes out 164, look for energy to follow and simultaneously break above the 31.25 level. The breakout area retest around 159 on Thursday was very clean and sharp, and unlike the SPY and QQQ, the Friday pullback in IWM didn’t give back much of the Thursday gains. The 160-161 area will be important Monday morning. While it could drop and retest 159, it would be a positive signal if 160-161 would hold, which would likely lead to a quick run at 164.

 

On the other hand, the IWM is probably the most dangerous place to be long if the overall market turns down. It has run about 16% percent in the last month alone and could easily give back 50% of that gain if things turn. A 50% pullback takes it down to about 153. As I wrote last week, when I finally get short the market, the IWM is probably the vehicle I’ll use to do it. The danger this week is if 164 gets clearly rejected. If that happens, you have to get out of the way of small caps and energy, because both could come down hard. Keep the stops tight on these. If I decide to try a short on the 164 failure, my stop easily goes in the 165-166 area.

 

UUP, GLD, TLT, USD/CAD – This is going to be an important week for the dollar. The UUP broke out from around the 25.25 area in late September and then pulled back to 25.10 as a retest. The retest held and the UUP jumped back above the 25.25 area to close the week at 25.29. It feels like the dollar might make a run at the 25.35 area and then make a move back toward the recent highs. If it does, that’s probably going to knock the USO down. The USO has made several runs at the important 29.25-29.50 area over the last couple weeks and has made lower highs on each test. If the UUP starts another run up, the USO likely drops down to test the 27.75 area and then the 26-26.50 area. As a sidenote, you can use the real WTI and DXY prices, I simply use UUP and USO because it’s easy on IB to track current prices in one place.

 

As the UUP turned back up, the falling wedge breakout that the gold bugs were watching failed and went flat. If the UUP continues upward, look for GLD to take out 177. If the dollar really strengthens ahead of the election, the GLD might not find demand until the 170 area. I took a long in the USD/CAD pair this week at 1.3102 and that turned out to be a good trade. I’m kind of regretting not cutting it up around 1.3260, but if the dollar does strengthen, I think this pair can make a run back to 1.34, and if it does that should signal a fall in USO. On the downside, the clear stop on USD/CAD is 1.3100, so if price drops I’m probably cutting the trade breakeven. A break below 1.3100 would probably correspond to USO breaking above the 29.25 mark.

 

In summary, energy stocks need a UUP down, USD/CAD down, GLD up, IWM up, XLF up macro to succeed this week. If the dollar doesn’t cooperate, things could get ugly for oil.

 

Big Picture Energy

In the larger scheme, the XLE has trended down from 39 on August 11 to hit a primary low around 29.75 on September 24. Since September 24, price has mostly been locked in a $1.50 range from 29.75 to 31.25. It did test below on October 1-2, but that auction failed quickly and returned to the 29.75-31.25 range. So what we have is a big downtrend which ended in late September and has turned into a sideways range. The question now is whether this current price range is an accumulation (which leads to a reversal and trend upward) or a distribution (which leads to more downside). I want to say it is an accumulation leading to an uptrend, but the problem here is that big downtrends usually need big consolidations to reverse. The move from 39 to 29.75 was a pretty big move and I don’t think that is going to be resolved and reversed with such a short consolidation. It’s possible, but not really probable. Unfortunately, that points to this latest range being a distribution. If so, there’s a big downside washout coming for the final lows.

 

As I’ve written for the last few weeks, I don’t think we’ve seen the final lows in energy. There still needs to be that final high volume capitulation to wash out the remaining holders and drive energy stock prices to levels where they can be accumulated by larger players for a longer term, low risk play. The sector isn’t going to turn with just a few funds picking up a handful of energy names. The only thing that is going to turn this sector in the bigger picture is a clear washout that removes much of the downside risk. With all that’s occurred over the last couple years, it’s fairly clear an oil price spike will materialize in the next year or two. New exploration has almost stopped and most projects have been cancelled. Demand has been crushed by Covid. However, even with all the Capex cuts and project cancellations and the dropping demand, oil price has managed to stay right around 40, which isn’t a bad price for oil given all that’s happening in the world right now. Over the next year, supply will probably hold steady while Capex and projects continue to remain stalled, however demand WILL come back. We are going to see a tipping point where demand recovers much faster than supply and that’s the root of the coming price spike.

 

There’s also the issue of inflation. If inflation kicks in like the FED wants, that’s going to hit energy prices, and will probably hit about the time demand returns. The key for larger players is how far out is the spike and how much risk are they going to have to take if they accumulate energy names now. They need the washout for lower entry prices and less opportunity cost lost until the spike actually happens. XLE at 30 isn’t a great deal for larger players, but XLE 20-25 would probably encourage them to accept the risk and holding time needed to take advantage of the coming oil price spike. Right now prices aren’t attractive enough to justify larger money passing up other sectors to tie up money in a longer term energy play. The sector needs that capitulation to draw in the larger players.

 

Majors – The action around XOM 34 and CVX 71 was encouraging. There’s clear demand at those levels, however there’s also clear supply up near 36 and 76. I think CVX is setting up for the better long trade if price comes down to the 70-71 level this week. I’ll still take the XOM trade around 33.75, but the stop needed on XOM is larger than the stop needed on CVX. I’ll get concerned about XOM if it takes out 33 and CVX if it takes out 70. I took a position in BP at 15.97, but I’m really starting to worry about that stock. There just doesn’t seem to be a bottom in that one. At least RDSA showed a higher low this past week, but BP just keeps falling. I probably should have waited to enter BP and will dump it at breakeven if 16 gets taken out this week. Right now my opinion of the majors best to worst is CVX, XOM, RDSA and then BP.

 

E&P – While that COP/CXO trade might be good for the sector, these mergers are really killing my pool of tradable energy names. CXO was one of my favorites and now it’s gone. In order to trade short term, I need price range and stock prices at least above $20. Right now there are only a handful of tradable names left and it’s shrinking quickly. I’m really only left with COP, EOG, PXD and HES. I may add FANG to my list to replace CXO, but I don’t really like the company. At some point I might be forced to add the second tier names to my short term trading list, but that gets expensive in commissions since I’m on a per share basis.

 

My primary E&P play this week is going to be COP long around 32. I think the final deal might get announced on Monday and if there’s any reaction to the downside I’m going to use that as an entry. I’ll also be watching 35.50 for a long play in EOG and 86 for a long play in PXD. My second favorite play this week is going to be a long in HES down near the 37 area. There’s very clear support to place a stop around 36.25 in exchange for the chance to make a run back up toward 42.

 

Refiners – This is still my best opportunity in energy and I’m looking to get big money in on the refiners on the next dip. PSX remains the favorite under 50. Also watching 39 in VLO, 27.75 in MPC and 19 in HFC. It could be a rough winter for product demand, but I think demand explodes in the spring. One way or another, this country will move on from Covid after the winter. You can only cage people for so long and at some point people will accept the fear and get back to life. And if there’s a vaccine, then spring will explode with travel and fuel demand. Opportunity occurs when things look the worst and for the refiners that’s probably now.

 

Natural Gas E&P – Still nothing here. The only play I’d consider is a breakout of 20 in COG, and even that trade isn’t very attractive because there just isn’t much reward in it. EQT just continues to grind and chop sideways. Last week’s pick of GDP did break 10 and got as high as 11.30, but then failed. There just aren’t any decent setups in this subsector.

 

ServicesSLB had earnings on Friday and the market didn’t react very well with SLB finishing the day down about 9% at 14.97. I was tempted to step in and try to pick a bottom on this one, but passed on it until I see earnings from HAL on Monday morning. If HAL reports similar, there’s probably more downside coming in services. The risk is that HAL reports worse because it’s more North America focused rather than international like SLBNOV and HP are still lagging near the March lows. One positive was the Friday rig report which showed a jump of 13 rigs, but even that was somewhat misleading because about half those were vertical wells rather than horizontal. At least it’s headed up and not down.

 

Trading Plan for the Week – Bottom line for the XLE is that it needs to hold 29.75 on any downside test. I will be putting on a short term long trade at 29.75 if the structure is good and I have a concrete placement for my stop. The key on this trade is having a tight stop. If 29.75 fails, there’s nothing down to 28 so the risk needs to be 29.40 or so. If we get the Monday pullback test, I’ll also be watching XOM, CVX, COP and PSX as my top four short term long plays for bounces. I’d also really like to take a shot long on any IWM pullback early Monday. I think there’s a good chance it breaks out above 164 and I’d like to find a way to ride that to 170.

 

If the XLE and IWM trades fail or if things just head straight down on Monday, I’ll step aside and see where the bottom is. I’d also have no problem starting a longer term scale in long on XLE if we test the 28.20 lows. There are so many different possibilities this week between long term and short term trades. I’m really trying to be patient for a longer term opportunity, but I’m having a difficult time passing up all the short term opportunities for small bounce plays. If the market looks really weak on Monday, I’ll probably stop short term trading and start focusing on where to get into some longer term plays. Also, if the XLE gaps up Monday I’ll probably just watch and see what happens at that 31.25-31.50 area. There’s going to be a test there at some point, but I think there’s a good chance the next test will be a false breakout, so be careful with that.

 

One thing I notice is that my weekly run through the S&P 500 charts showed a high number of stocks that are setup for short plays. That could have just been the way the week ended, but worth keeping in mind. Other non-energy stocks that might offer some opportunity:

 

Casinos – These have been on my radar for months, but they just haven’t set up properly yet. I’m watching 20.50 in MGM, 43 in LVS and 70 in WYNN. Every time I get close to pulling the trigger on these, the Covid lockdown talks starts to intensify. I don’t want to play these and then get hit with Vegas closing again. The best opportunity is to just wait and see if it happens and then take advantage of the overreaction in travel stocks for the play.

 

Homebuilders (ITB)- This group might finally be hitting the wall on this latest run. Watch the 57 area on ITB. The charts for each of the individual names all look like they could be about to reverse. I wouldn’t short them, but if you are long it might be time to ring the register and cash out.

 

Trucking – Some big reversals on Friday in this sector. Probably not time to short, but like homebuilders be cautious of the group on the long side.

 

V – Another short term bounce play off the 198-200 area back to 208. Tight $1-2 stop.

AAPL – Short term bounce play long off of 118 back to 126, same $1-2 stop.

MSFT – Short term bounce play long off of 216 back to 225, $2-3 stop.

CMCSA – Still watching for this one to break the 47.50 level to new highs.

CSX – Watching for an 81 breakout to blue sky above. Same for NSC 223.

FCX – Breakout of 17.50, target 20.
NUE breakout of 50, target 56.

JPM – Play long off of 100, 98.50 stop, 110 target.

NEM – Short off of 64, stop at 65, 59 target. Watch the UUP and GLD for confirmation on this one.

OMC – Long on a low volume pullback to 50, 47 stop, 57 target.

 

As you can probably tell, I’m kind of in no man’s land on energy right now. I feel like there’s some positive things occurring under the surface, but I also fear there’s a final washout that’s needed. I’m really on the fence right now and very cautious. I’ll probably play smaller positions this week and favor standing aside in order to have plenty of dry powder if we do get that washout. Being nimble is probably best right now, especially with the wildcard election approaching. Good luck this week.

 

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