Weekly Energy Equities Review and Market Outlook for April 20-24
Apr 19, 2020 Trading Blog
The same question continues to circulate in the energy sector: “Is this the bottom?” I addressed this in my March 21 post and I think those answers are even more relevant now after seeing Friday’s action. I think we are at the bottom for the energy sector, but I’m not sure if everyone’s definition of “bottom” is the same. For me, the bottom is a process, not a single price point. The lowest price point isn’t what defines the bottom of the market. Also, you have to continue to ask yourself, if we are at the bottom, would I buy it here? Just because a market has reached a bottom, that doesn’t mean the next move is higher.
As some of you know, almost all my trading is based on Wyckoff principles in one form or another. I’ve been posting for awhile that we could be looking at an accumulation type range/bottom forming in energy over the next several months. If we are, then we are still very early in the game and likely just moving into phase B of the accumulation. Phase A was the strong downtrend, the preliminary support, the selling climax and then the automatic rally. There’s a good chance that the April 9 high completed the automatic rally which began on March 24. We pulled back from that high this past week, but could give it another quick look next week. If we are in a Phase B, then a move back toward 37-39 will get rejected cleanly and price will move back toward the range fair value, which now sits about 28-30. I think many people are expecting a V shaped price pattern, when what we might actually get is an L shaped consolidation for a few months. Also, even if we are at a market bottom, there’s a good chance that price will make one more low in Phase C before the markup phase starts. If we are in a Phase B, then you want to be buying near the lows of the range, not up here at the top of the range near 37.
As for Friday’s action, that was a clear divergence and a screaming signal that the bottom is in for energy stocks. Oil hit lows around 18 while the XLE was up 11%. Signals don’t get much more obvious than that. The trick if you want to buy in for the longer term is to time the next couple of pullbacks correctly and then not get shaken out on the final spring which may come later in July/August. I’ve been saying this for awhile, but before the next uptrend can start, there must be a transfer of a majority of the stock into the hands of longer term holders who will lock it up for years. I think that’s what we were seeing on Friday. If you are a larger fund and your target price for XLE is 60-70 in a couple years, then there is no difference if you buy in at 33 or 36 on any given day, it’s meaningless. Funds were paying up on Friday, but only compared to what we would deem wise as shorter term traders. For them, paying up is just a nuisance and part of acquiring a large position. They will back away from the market soon and let price fall and start the whole process again until they fill their positions. For them, it’s the average price of their transactions over the longer term that matters, not just the price they got on a single day.
As the range continues to form, there will be tests of the top of the range to see if buyers pile in or sellers appear. There will also be tests of the lower range boundary to see if new bears appear or if other larger traders step in trying to get a deal. The key is to realize that these tests are going on and then take advantage of them for longer term entries. We just have to be patient and let the range evolve because that’s the way a bottom is formed and completed, which then leads to the next uptrend. The length of this accumulation process is going to be linked to the demand side of the oil supply/demand equation, which in turn is linked to the current virus situation. We saw the Trump plans to open the country on Thursday, and the resulting pop in energy stocks on Friday. The demand side will control for the next couple of months, so focus on that rather than the supply side.
Overall Market SPY IWM
I’m not sure what to say about this latest market bounce off the bottom. I theoretically understand why it’s happening, but from a practical common sense point of view I just don’t agree with it. It’s a liquidity driven move created by the actions of the FED, that’s it. You can’t fight it. In this kind of situation, there is no “market” as we have previously known it. It will return one day, but for now all we have is this liquidity pool with no place else to go except stocks. Life outside the stock market is a disaster. 22 million unemployed, thousands of businesses destroyed and a consumer who has been psychologically scarred and may not recover for 6-12 months, or longer. There are two parallel universes occurring, one is real life, the other is a synthetic holding company of 401k’s that can be manipulated at the whim of it’s controller. To trade this, you just have to understand which universe you are trading. At some point though, they will intersect again, and the destruction could be huge.
I’ve traded through a couple bear markets and they were long drawn out affairs. This current market move is eight weeks old. Eight weeks is not a bear market, it’s a correction in a bull market. The question from here is whether the correction completes with new highs or if this really is a bear market and this bounce is followed by a move to new lows. I don’t know the answer, but what I do know is that we haven’t confirmed a bear market yet, so you have to keep trading like this is just a correction in a bull market. Let the market tell you whether this is a correction in an existing bull market or the start of a new bear market.
Technically, it was a solid week in the SPY, although the volume was a little low. The key is whether this low volume is demand backing away from the market (which can return) or whether the sellers are running out of supply to sell. The SPY closed right near the 50 day moving average (285.82) and could take a shot at the 200 day around 300 later in the week. There’s really just nothing to stop this market. If 22,000,000 unemployed in a total economic shutdown can’t stop it, then what can? I’m watching the 270-275 area on the downside for support. The VWAP off the top on February 20 sits at 270, so that’s the important point to watch to see if the uptrend continues. If 270 breaks, then 262 comes into play. On the upside, I’m watching the 300-305 area, which was the July-September 2019 highs area.
The more concerning thing for me is the IWM. It had a terrible week compared to the SPY. The smaller domestic businesses in the United States are struggling. The IWM and XLE are both good measurements of the US consumer, and the IWM is saying that the consumer is in bad shape. That’s not a great signal for future oil/gas demand. The SPY is threatening to take out that 61.8% retracement level from the top, yet the IWM can’t even make it past the 38.2% retracement level. Money is looking for safety in the big caps, especially big cap tech. The component weightings in the SPY and QQQ have become very skewed toward just a handful of stocks. Money is looking for safety in quality, but if that handful of stocks finally crack, the market tanks. Keep an eye on that 125 level for IWM this week to see if it gets rejected again. On the downside, watch 114-116 to see if it breaks down.
I posted a few weeks ago that I put 25% of my wife’s 401k cash into the SPY around a 232 average price. If this market makes a move to the 300-310 level, I’ll probably be cashing that out and taking the 35+% gain that was made in just 4-5 weeks. I was expecting that kind of move to take 1-2 YEARS, not weeks. I also don’t think the market has made its final lows yet, so the gamble of taking the profits and waiting for another entry is justified. When you look at the SPY, you really have to ask yourself if many others who bought the dip will start doing the same thing soon. Also, there’s a huge group of older investors who got absolutely shocked by seeing a 35% drop in their net worth in a few short weeks. I’m thinking that those older investors start to lighten up as they make those losses back. Those investors have recouped about 60% of the losses, which isn’t a bad time to move into the safety of cash. Sometimes when you are trying to predict the direction of a market, just look at what your decisions would be if you were in, and also the decisions of other traders/investors. Even though the FED and liquidity controls this market right now, there’s still a large human greed/fear component.
Energy XLE XOM CVX WTI
The best place to start this week in energy is WTI itself. What a disaster in the actual commodity. WTI closed near 18 and is showing no signs of bouncing back. As expected, the OPEC cuts had zero effect on the oil market. It was just a dog and pony show of market forced cutbacks. I’m really not sure where the downside is in oil. Last week I posted that I thought the downside was probably about 20 for the week, and I missed it by 10%, not good. I really don’t see oil bouncing much this week and it likely stays in this 17-23 range for awhile. The funny thing about oil is once it hits the bottom, the reversal and bounce is enormous, and very hard to catch. Oil is a tough one to predict and that’s why I don’t trade it. It’s much easier to let oil be my North Star and just follow it a step behind in the actual oil producing companies. I’m having trouble keeping up with the manipulations of USO and the current rolls to second month futures, therefore I’d follow the actual oil futures prices rather than USO. The only good thing this past week was that energy stocks diverged greatly from oil price, so don’t get too hung up on what oil is doing this coming week.
The XLE finally gave us a clear signal of a bottom with the divergence from oil prices on Friday. That signal has flashed a few times over the last couple weeks, but none of them brighter than what happened Friday. It’s my opinion that we are going to spend a majority of our time in a range between 24 and 37 for a few months, but that doesn’t mean we can’t get the occasional exploration outside the range. There’s a good chance that the XLE probes the 37-39 area this week just to see what’s outside the range that started back on March 9. There’s also a very small chance that price could actually close that March 9 gap down from 42. I really don’t think that happens, but you have to be aware that those gaps love to close and sometimes act as a magnet on price, and therefore you have to protect yourself against those possible moves if shorting the top of the range.
The more likely situation is that XLE conducts a retest of last week’s highs around 37 early in the week and then rolls over and ends the week around 30. There’s really not any big news events expected in energy, so the sector might get dragged along with the SPY. If the SPY peaks and turns down, I don’t see the XLE diverging from that and it should follow SPY down. Same on the upside, if SPY runs to 300-305, then that increases the chances of that 42 gap closing.
XOM and CVX both had a good week, with CVX being the stronger of the two. CVX closed right on the 50 day moving average, while XOM still lagged about $3 under the 50 day. Last week I posted pullbacks on XLE to 29-30, XOM to 39-40 and CVX to 75-77. The biggest miss was CVX and it appears to be the strongest and makes a good long candidate this week. I still like XOM, but the momentum just seems to be stronger with CVX.
The services names are still lagging. SLB had earnings on Friday and HAL comes out with earnings Monday. Things were about as expected in the earnings report and SLB managed to put in a solid green day, up about 9%. It was difficult to tell how much of that gain was merely a sector move versus an individual move based on earnings. See if the service names diverge from the E&P’s this week. Also, keep an eye on NOV, it’s setting up for a nice breakout of the $12 level. The chart is setup nicely for a tight stop and an excellent risk/reward on a long trade. BKR is also another nice setup for a breakout long with a stop at 12. If services do break to the upside, my first play would be NOV, then BKR. The two larger players, SLB and HAL, could lag.
I posted about the offshore names last week and I did some research into the names, but what a disaster these stocks are. I didn’t find anything that looked attractive. The theory is there that these could do well, but the balance sheets and debt just make them unplayable. If I was forced to buy one, I’d go RIG, but I’d rather not. Sometimes things look good in theory, but in reality they remain trash.
The natural gas names COG, EQT, RRC, AR and SWN continued to show nice gains. I have no faith in this group and won’t be chasing at these prices. The cuts made by the oil E&P’s are helping the associated natural gas production, but I don’t see much future in trying to invest in that theme. There’s a good chance that natural gas could reverse at any time, and it usually reverses big. I’m avoiding the natural gas names.
As for the E&P names, I really missed a great trade in COP. It pulled back perfectly to the 30.75 VWAP’s off the March 9 and March 18 points. It’s rare when two VWAPs line up like that and I should have taken the trade. I’ve said this so many times before, but energy stocks move so fast that you have to be in prior to the big moves or you miss them completely. COP opened gap up $1 and then moved $2 more in the first 30 minutes. I had no desire to pay $3 over Thursday’s closing price, and therefore I just let it go. There were other stocks in the same situation, but COP was my favorite. Watch the 31 level on any pullback. EOG was another possible long trade, but I was waiting for the 35 level to take a chance, but it never got there and closed ~42 on Friday. There’s really nothing in the E&P space that I’m willing to pay these prices for. The only thing to do is just let them fizzle out on this run and then pullback again. There could still be some run left in them, but the risk/reward is just too expensive for me right now.
Trading Plan for the Week – Monday is going to be a difficult day for me to do anything. I think this market likely gaps up, but I’m not interested in chasing that gap up on the long side. I’m also not comfortable shorting after last week’s big run. The plan for me is to sit it out on Monday and see how the XLE acts around the 36 level and the SPY around the 293 level. There will be good signals at those levels for the rest of the week.
If the XLE gaps down for some reason, I will be interested in trying some long scalp plays. The first solid demand level is 32.69-32.89 and I’ll probably try an intraday long there. The next levels down are 32.25 and then 30.75-31.25. I’m not interested in trying any short trades above 30.75. If the 30.75 level does break, then there will be plenty of time to get short as it falls. The same long scalp play can be found in XOM around 42 and CVX around 82.50. As I said before, I like the CVX play a little better than XOM.
It could be a really slow week trading in energy, but IWM should offer some great daytrades. My biggest trade for the week will probably be a swing short play on IWM around 125. I think the small caps will test last week’s high and fail. It’s a risky trade, but there is a good $1.50 tight stop around 126.50 and the reward could be $10 if the trade is correct. If IWM gaps down Monday, I’ll be looking for a long daytrade scalp off the 119 level.
There is also a good trade setting up on GDX around 29. If Monday gaps down, then see if 29 stops the fall. If it does, I’ll scale into a long position with 1/2 a position near that level and then add the other half if GDX can reclaim Friday’s 29.93 close. If it fails to regain Friday’s close, then stop it out around 28.50 and look for another opportunity around the 26.50 area.
This is one of those market weeks that could go either way and I don’t really have a long or short bias. I’m probably going to spend most of the week on the sideline letting this market show me where it wants to go from here. Some weeks are just slow. I recently started posting again on Twitter, but the same problem of distraction and emotion just keeps returning for me on that. It all just seems like everyone complaining and trying to tell everyone else what to do and what they should think, and that pretty much goes against everything I am. I’ll probably be scarce on Twitter this week. It’s such a great thing to cure boredom, but it’s also a killer distraction when I should be focusing on other things. Good luck this week and keep an open mind about market direction, don’t get locked into a single direction.