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Thoughts on This Week’s Big Energy Move and a Nagging Bearish Bias

I’m conflicted right now. Something changed in a major way last week and it was likely completely external to oil and its fundamentals. I watched my energy names all run about 10% last week and about 25-30% over the last three weeks, but my directional bias moved more to the bearish extreme rather than toward the bullish action being represented on the charts. The real problem is that I don’t have one specific concrete reason for it. I should be bullish. There was massive buying which lasted most of the week. The overall market is at all time highs. The election is done and behind us with good results for the market with a split Senate and presidential winner. Things should be perfect to jump on the bullish train and ride it for all the profits it gives. Except something is different and it just doesn’t suit the way I trade. Mostly as a therapeutic exercise, I’ve tried to list below all the reasons for my bearish bias.


The only logical answer I can come up with is that none of the fundamentals of the energy industry have changed. If anything, things are about to get much worse as more waves hit and more lockdowns take hold. This is going keep dragging on until spring, if not longer. This virus, just like flu and colds, is here to stay for the long run.  I posted this on Twitter back in March and I’ll say it again: “We will ALL get this virus eventually, get your body in shape now”. If the energy fundamentals haven’t changed (or are getting worse) and the stock prices are going up, then something else external must have changed. I think what we are seeing in energy is purely a technical event, not a fundamental one.


The problem with technical events is that they usually make no sense when compared to the fundamentals. And that’s exactly what bothered me last week. There was no fundamental reason for what we saw. The only justifiable reason was that energy was the other side of a tech trade that was being unwound. Some would say it doesn’t matter, simply buy and ride the ride. I mostly agree with that, but that logic is difficult in energy, especially if it conflicts with how you trade. When you try to trade based on technicals that are directly opposed to the fundamentals, it’s so much harder to control risk and almost every trade becomes way more expensive than it should be. There’s a double whammy on every trade that elevates risk above normal:  either the technicals will reverse because of something that has absolutely nothing to do with oil OR the technicals will reverse because of something that has everything to do with oil, however you don’t know which it is until the move is over. It’s like trying to play two games at once, and that’s difficult.


So what to do? For me, I have to get out of the way here. My plan this week is to take a step back and probably take the week off, watch the action and let these opposing fundamentals and technicals sort themselves out and get back in alignment. The market will still be there the week after and if things settle out and show me something good, then I’ll gladly jump back in.  However, there are just so many conflicting issues right now that I don’t really see a clear path. This is a different writeup than usual, mostly because it is just me trying to figure all this out on paper and record it for later review to see how things transpired. I’ve posted a lot of bullet points below that are just thoughts on what I’m seeing. Some probably make no sense, but I like seeing other people’s thought process, so I figured I’d offer mine. So here we go.


1   This week we had two opposing forces hitting simultaneously:  new waves of lockdowns and vaccine hype. Which side won? Why did the vaccine hype win this week according to stock prices? Will the pendulum swing right back if the vaccine fails in any way or if the lockdowns intensify in control or duration? And what do we know about the Biden lockdown approach that begins in about eight weeks? If the market swung that big on a simple vaccine hype, then how far does it swing to the other side on any announcement that might be equally as bad? Are we looking at another Monday in the opposite direction soon? How do I control risk if such flimsy news announcements are causing such huge moves?


2.   What are the odds that everyone could have moved to the same side of the boat Monday at exactly the same moment? The standard deviation on this move was realistically impossible according to quants. So what really caused it? Was it really the vaccine hype announcement? Or was it something else completely? Is our stock market so concentrated in the hands of so few major holders that their moves are this massive? There’s a huge amount of stock in the hands of the Blackrock’s of the world. If these kinds of moves can happen, then it’s equally possible that any day we could wake up to a move in the opposite direction. If so, how do we even begin to control risk if infinite standard deviation moves happen?


3.  What kind of players entered the market on Monday’s move? Is this just a temporary fast money play or was this longer term players expecting a long term trend? If we don’t know, then how can we put on trades with any normal risk control? If it was short term players, then this move could reverse just as quickly as it occurred, especially on a larger external event opposite of “vaccine hype and hope”.


4.  If this market moved this much on a simple “vaccine hype” announcement, that what kind of move could we be looking at on a much more serious news event? A geopolitical event? A terrorist event? How much is risk elevated now and how do we safely play in this kind of environment? What would happen to the relatively fragile market on a true black swan event?


5. The primary unwind right now is the exit of QQQ with that money moving to XLF and XLE.  Generally, it’s a tech to cyclicals move. However, the correlation only seems to be working at certain times of the day. Traders are unwinding this trade randomly during the day. They are also randomly unwinding it on certain days. Monday, Tuesday and Friday were unwind, Wednesday and Thursday weren’t. How can I trade this random movement with any consistency? How can you hold any trades overnight with such randomness on the primary cause of market direction?


6. Not only is there a randomly occurring QQQ to XLF/XLE correlation going on during the day, but there’s also the Dollar/Oil (UUP/USO) correlation happening. We have two correlations competing in effect on XLE. How do I trade energy names with two very large correlations often competing with each other and moving in opposite directions? Neither the QQQ unwind nor the weak Dollar is dominant right now. These correlations are the basis of my normal trading, so how do I trade when these two correlations turn on each other at totally random intervals?


7. For any longer term energy positions, how long will this QQQ unwind trade last? How big are the players who need to unwind it and how long is it going to take them? Are they going to unwind it all the way down? Is this just one or two players unwinding? If I don’t know the extent of the unwind, then how is it possible to put on any longer term trades? I saw a Barron’s article today suggesting this rotation could last for “months”. I doubt it, but obviously there are people out there who read it and believe it. I could put on a long term trade today and the tech to cyclical trade could end tomorrow, especially if this whole thing was caused by something as flimsy as “vaccine hype” in the first place.


8. At what point would this tech to cyclical unwind turn into an all out squeeze or meltup?  Will there be momentum funds that blowup and get liquidated, thereby pushing the market further than it would normally go on this kind of news event? Would that be the prime spot for a trade, specifically a short IWM or short XLE trade if this unwind trade gets out of hand? Is the market creating a situation completely controlled by portfolio rebalancing rather than fundamentals, and if so how do we take advantage of that?


9. The XLE has moved from 27 to almost 35 in twelve trading days, which is about 28%. At what point are you late on this trade and chasing the action for a horrible entry price? Do the fundamentals even come close to justifying this or is this move purely caused by the tech rotation unwind? If we don’t know, then how can we trade it with any confidence? If we can’t trade with any confidence, then how can we control risk?


10. While the XLE appears to be looking exceptionally bullish on the outside, how much hidden damage has occurred that has weakened the inside underlying structure? This bullish move has created a couple of bearish problems. First, all the shorts are out. They did their buying and they are out of the market. What happens if this great unwind trade suddenly stops or some other external event occurs and the XLE starts down quickly? Who stops the fall? The cushion of shorts covering on the collapse is not there anymore. Also, if the guys who have been shorting energy are now out, then there’s a really high probability that they are waiting to put those short trades back on just above the market. So they can cap the upside action. Also, the XLE did 297 million shares last week. I can’t remember a higher volume week. If the XLE starts down again, where do those new buyers get nervous and throw those 297 million shares back on the market? And even if the XLE goes up instead, were these new buyers short term players who will sell for 10% gains and therefore cap the action near the summer range? Have we created a situation with new shorts waiting just above and new longs ready to take profits just above that we have effectively capped the reward on any trade taken here, but we still retain large risk back to lows? How fast would these new longs bail on the market and accelerate any move down?


11. How much supply is sitting just overhead that remains from this summer’s range? Are those players just waiting to get out breakeven? With all this buying power being used up, will there be any left when we reach that summer range? Will there be enough buying power left to take it out, or is price capped there for a high risk, low reward trade?


12. Almost every energy name is now sitting squarely between the 50 day and 200 day moving average. Prices just moved above the 50 day last week, but are still below the 200 day. Are these names merely bouncing back the the 200 day moving average as a regression to the mean? Will prices be capped there? Will there be enough buyers remaining after such a large run up that they will be able to take out the 200 day? Or is price once again finding a cap for a low reward, high risk situation?


13. The UUP is making a solid base in the 25-25.50 area. What happens to oil if the dollar bottoms here and starts upward? Can XLE and USO survive with that kind of headwind, especially if the tech to cyclical unwind stops? What if the USD/JPY has just had a false breakdown and it finds big demand in the 104.25 area? Same for the USD/CAD pair at 1.3050? Both of these currencies tried to break down but failed. Can oil continue to ignore these signals?


14. When does the TLT find a bottom? If it does, and rates start back down, will the financials follow it down? Would that kind of TLT move stop the tech to financials portion of this tech to cyclicals rotation? Banks and energy have a very high correlation right now, so will the two diverge or will energy follow banks down on any big TLT move up?


15.  Are traders really going to abandon tech? Are they really going to abandon the one area with the most growth prospects? Maybe it is extended and maybe it’s time for cyclicals’ day in the sun, but when things get tough and the fundamentals of cyclicals don’t improve in a Covid handicapped world, will players rush right back to their old tech love? Will the flavor of the day banks and energy names just get tossed back on the scrap heap? Will the fundamentals of energy EVER be better than the fundamentals of tech? Now that energy names have jumped 28%, how much would energy fundamentals have to improve to justify that price? Now that tech has dropped so far, how much would tech fundamentals have to improve to justify their price? Has the recent price move actually made the fundamentals of energy LESS attractive now as compared to the fundamentals looking MORE attractive in tech with the associated name prices?


16. From a technical point of view, is the QQQ chart really breaking down or in any danger of breaking down? Or is it consolidating for a major breakout to all time highs with a big stimulus package on the horizon? I’m not willing to bet against tech here. If you are playing energy long based on the external unwind of the tech trade, you might as well be shorting tech. I don’t short tech. Ever.


17. At what point do all the headwinds above start to overwhelm the tech to cyclical unwind? And how fast do these extended bank and energy names fall if these headwinds take hold AND the tech to cyclical unwind stops?


18. And if all the above weren’t enough, oil is still a shit business that doesn’t really make any money. It’s a stagnant, debt ridden industry that is decaying as renewables and electric vehicles take over the world. How exactly do funds plan on selling a new fossil fuel dream to their holders, especially in this age of ESG investing? Was this week’s big move really new buyers? Or was it simply funds covering short trades which were acceptable to their ESG clients?


19. What about the political landscape for energy? How will things change under a Biden administration? Is this latest move really a reflection or expectation that this administration is going to help fossil fuels in any way over renewables? Or again, was it just short covering on the tech unwind? And if all this was just because of the unwind and there’s no real fundamental reason for funds to be in fossil fuels, is this whole move just an illusion waiting to be shattered when the unwind is over?


20. The XLE and USO diverged sharply on Friday. Has the commodity run out of steam first? Is this a warning that the energy equities have been caught up in FOMO buyers? Does the divergence continue? Also notice that the USO topped out right at a major level around 29.50-29.75. Does it make another run at that level?


21. And one last one for the conspiracy theory voice in my head. You ever wonder if funds would actually orchestrate a “value narrative” in the media just so they can have a reason to dump all this shit they know is NEVER coming back? I mean look at the tiny 2.5% pullback from all time highs in QQQ. Does that really justify or correspond to a 28% move up in energy? Is this whole “tech to cyclical” rotation just a fabricated narrative to take advantage of the naive?


As you can see, I’m definitely conflicted on energy right now. With so many crosscurrents, it’s hard for me to have any confidence with the short term way I trade. But more importantly, it’s also hard to have any realistic risk control. So what we have here is me trying to trade my normal method in an environment for which it isn’t suited and at the same time taking very expensive trades with almost non-existent risk control. Not a good combination. Sometimes the market just isn’t conducive to certain types of traders and I feel like that’s me right now. Sometimes the smartest move is to just step aside. No need to be a hero and chase this energy move. The market will still be here when it’s over. Don’t let greed entice you into doing something that you aren’t good at. Anyway, just wanted to try to explain why my bias is so bearish in the face of such a bullish move in energy. It definitely hurts to miss the move, but it hurts worse to violate all your trading rules and lose because of it. So I’m on the sideline this week. The only way I get back in the game this week is if the XLE makes an absolute meltup to a ridiculous level, which I’ll gladly short OR if the XLE totally collapses, at which point I’ll have no problem starting in long at the right price. I have no idea what those prices on either extreme might be, but hopefully I’ll know them when I see them.

Good luck out there this week. Take it slow and play it safe in this environment. Keep the powder dry.

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