Oil and Gas Equities Outlook for Monday, April 16
Apr 15, 2018 Trading Blog
It wasn’t a good week for my short XOP position due to the Syria and geopolitical events and it looks like I’m going to be on the sideline this week in energy. I feel like I’m the lone bear in a world full of bulls, but right now the market says I’m the one that is wrong. I’m not a fan of trading wild volatility based on news, war and speculation. I find that my results are much better trading stable, organic supply/demand based markets. The high emotion in the market seems to throw me off every time. After trading for 18 years, the risk side of the equation has become way more important to me than the reward side of the equation. I do think that there is a great short setting up in energy, however it may not be prime yet. I’m still short bias and I have ZERO desire to jump in on the long side way up here. There were multiple chances to buy under 34 and once you missed that, anything else is now probably late chasing price. For any long position, the better move is to be patient and let it retrace back to the breakout point after the emotion drains out. If it runs further, so be it, it can do it without me. Sometimes you have to stick with your view, no matter what all of Twitter, News or the Herd says.
I think there are many people who WANT energy to go up. Many bulls are so ready and desperate to buy these stocks that the bull side could get severely overdone. These stocks still have the same issues they have always had with loads of debt, low cash flow and outspend. One thing I think people have absolutely missed is the danger in a slowing economy and what that will do to oil prices. They have also missed the danger in how an oil price shock itself can damage economic growth. So much attention has been directed to the supply side, that most have given no thought to the demand side. When oil prices rise like they are now, the threat of economic damage becomes more real. Higher energy prices can bring about their own demise. Higher energy prices also produce inflation, which in turn could provoke the FED to accelerate rate increases.
Another thing that I see coming is that energy companies are going to change course on their spending and could pay a hefty price for that mistake. With oil prices rising toward $70, I don’t think most E&P’s are going to have the discipline to stick with the previous estimates and budgets on spending that they recently gave Wall Street. They are going to be lured by this oil price spike into increasing their spending and drilling, and that could bite them if oil price suddenly turns back down. When companies start increasing the spending, Wall Street might not take too kindly to the change in plans. In addition, what happens if they do increase their spend and then we get an oil collapse? You get the double whammy of Wall Street being angry for the deception and lack of discipline AND the company gets hung out to dry on the extra spend without collecting the reward due to a declining oil price. Keep an eye out for the first company to increase spending and take note of how the market reacts. And how about those stock buyback programs? Is buying back stock at these elevated prices a good deal for shareholders? A very tricky situation.
I think what we are seeing now is a very temporary condition. I see everyone moving to the same side of the boat in a panic based on emotion and war based expectations. I don’t see a prolonged run in energy stocks. What I see is an emotional spike based more on geopolitical fear and news rather than a sustainable increase based on fundamental supply/demand and company fundamentals. When the emotion wears off, things can get really ugly, really quickly. I used to trade gold and it is much the same. It can run on emotion, rumors and hype and then one morning you can wake up and it is down $100 bucks. Oil can do the same. You just never know. That kind of emotionally fueled environment is a very difficult one in which to control risk.
Technically, this formation on the XOP chart just doesn’t make much sense. The spike, crash, upward bear flag and then resulting spike out of that bear flag isn’t a normal formation. It is almost as if the sector got to the top of the range and totally panicked because of the war rumors thereby catching everyone, mostly bears, offsides (me included). It’s just a rare occasion that a market comes off that hard, goes into such a short consolidating formation and then spikes right back to the upside without at least some pain at the bottom of the formation. We had no real test of the lower bounds of the range. The only real explanation for that kind of pattern formation is emotionally based trading action. How long can the pattern sustain based on emotion?
Energy stocks have also become such a small portion of the S&P500 that I also believe they can be easily pushed around by institutions looking for quick returns, with absolutely no associated increase in the underlying fundamentals of the companies. That last spike to 40 in the XOP was a great example. Does that spike repeat itself in the coming weeks? Are funds taking advantage of the fear and world events right now to excessively push the price up? Who knows. Do you want to get all in long to find out? I don’t.
We also still have the SPY in a bit of an unresolved position. Being bearish, I don’t think we have seen the bottom of the current correction. While the market seems to have stabilized, I still think we have the possibility of turning down again toward that 245 level and possibly further. I’m definitely finding it hard to justify taking any longer term long position right now given the risk of a further market correction. I’m probably overreacting on this, but you can’t deny that the possibility is still there.
Sometimes trading is good in a certain sector and sometimes it isn’t, it really depends on how you trade. For me, this environment in energy is not a good trading environment. I’ll be on the sideline until the emotion drains out of the sector and things settle down. I’d much rather find a more stable environment to trade while the geopolitical events resolve themselves in energy. I’ll still have my eye on energy in the coming weeks, but I’m more likely to be intraday scalping the SPY rather than looking for swing trading opportunities in energy. I will get interested again if the XOP reaches the 40 level and I will be looking to put on another short up there. Until then, patience is the better move.
Good luck this week, and please be careful in this type of environment. Use stops, keep the positions small and keep risk control as the most important thought each day. That fear and emotion premium in the market can drain out very quickly leaving longs shocked.