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Weekly Energy Equities Review, Market Outlook and Trading Plan for March 1-5

The market finally started some type of pullback, however it remains to be seen if this is just a little pause before what I think is the final blowoff run or if the market has already topped and we’re on the way down. My recent bearish bias has been borne out of this run that originated in November. It just has that “late bull” feeling to it and I really think the end is near, likely within the next few months. I’d be really surprised if this bull market continued for longer than six months, especially when it runs into the next September/October period. The market is running on incredible liquidity, relief packages, stimulus, free FED money, zero rates, etc. It’s probably 2 a.m. and the party is in full swing, but it doesn’t last forever, and someone is going to get stuck cleaning up this mess. I don’t want you guys to think I’m some crazy permabear, but after 22 years of trading, I’ve been mauled by a few. It’s never fun and the worst part is that it happens before you ever see it coming. More like quicksand rather than an all out attack I’d say. But enough of the bearish buzzkill, the only thing I can really say is be responsible, manage your money and protect yourself best you can. On to the macro picture.


SPY – The price failure Wednesday afternoon was significant. The 392-393 area will be a difficult level to recapture. I think it was the force and speed with which the rejection was created that was most important. It had the feel of an upthrust pattern that got rejected before it was able to complete. It’s like traders were trying to take it up quickly, pick the stops and establish short positions before the fall but there was so much supply that they couldn’t manage it. Nothing newsworthy occurred after the close Wednesday, yet the bears were out in full force from the opening bell on Thursday, as they took it from 392 all the way to 378. Many of the recent pullbacks have simply been buyers pulling back, but this one was different, it was heavy selling volume and there really weren’t enough bids to absorb it. The volume on Thursday and Friday was significantly above average, as were the daily ranges. Those two things tell me that this was active selling. Someone wanted out, maybe some kind of rebalancing month end or maybe true selling. It will be interesting to see if that group shows up on Monday morning.


There’s a VWAP in SPY which started back on October 30 which represents this entire bullish leg (the one that has turned me a bit bearish). That VWAP is currently at 371, so that’s going to be an important point if this pullback continues. If price drops below that level and starts to establish, that suggests that this might be an extended move down, both in points and time. To even give back a quarter of this run off the March bottom would take the SPY down to the 355 area, which would be right back to where it was on the November 9 vaccine announcement. That 355 would be an important decision point in the larger picture. I don’t want to get too far into the future, but the 325-350 area could be a potential target on the coming SPY pullback.


QQQ – Tech was simply a disaster this week, but there was one good thing which I don’t think many noticed. As with the SPY, there is a VWAP from October 30 in QQQ which sits at 310. The QQQ bottomed three separate days in the 311 range. Watch the 308-310 level on Monday. There’s also an uptrend line near there from the March lows. If price establishes below 308, there is probably more downside to the 292-295 area. Any drop below 292 could open up 263-266. I doubt that happens, but that’s where the levels are. QQQ is trading in correlation with rates right now. If the TLT can stabilize next week, there’s a good chance QQQ holds that 310 VWAP and makes a nice recovery, much like it did in September and again in October. One other point, QQQ has been trading inversely with IWM, so watch that correlation. If QQQ recovers, that could signal a further pullback in IWM, or at least some sluggishness, which wouldn’t be a good thing for XLF and XLE.


IWM – Much like the SPY, the IWM had a major rejection in the 226.50 area on Wednesday afternoon which led to a selloff down to 215. I really think there still might be a bullish blowoff leg coming in IWM to the 245-250 area, but the action on Thursday and Friday was definitely concerning. Small caps will have to defend the 215-216 area early in the week or there could be a pullback coming that could take it to the 200-205 area. The October 30 VWAP for IWM sits at 198. As I posted last week on Twitter, I’m looking for something to play long for the blowoff  top and IWM is probably going to be my chosen vehicle. I’ll be watching that 215 area on Monday and if it looks like it’s going to hold, I may start building a long position for a ride to 245, however it’s going to have a very tight stop on it and may take a couple of tries. Size appropriately.


TLT – It was a wild week in TLT, just an absolute freefall down to the 137 area. As I’ve written the last few weeks, it’s probably inevitable that equities finally get concerned with rising rates, and we saw that last week. Was that 137 level the tipping point for equities? If equities are going to recover, the TLT needs to establish a bottom. I don’t think it really has to bounce higher, as just establishing a base would probably be enough to soothe the equity markets. Rates don’t need to start going down, they simply just need to stop going up. The perfect scenario would be a big bounce in the TLT (lower rates), as that would probably send SPY and TLT moving in the same direction for awhile. If rates start to slide back down, that could be the force that propels the final blowoff leg to the upside in equities. It would be a Goldilocks situation.


GLD/GDX – As the TLT continues to fall, so too does GLD. The two have been moving together since August of last year and the correlation remains in the bigger picture. As with most market correlations, as you drop to smaller timeframes, there’s less exact correlations. Almost all of the correlations I work with are on daily charts. While the TLT may well correlated with GLD, the more important correlation for gold right now is the UUP. They diverged sharply on Thursday and Friday with the dollar finding a bottom and gold breaking down below some significant support. The real question now, and the basis of my GDX trade, is whether this is a major pivot point in UUP or simply a small bounce in the dollar that washes out the stops in GLD/GDX and leads to a leg up for gold once the dollar fades again. Over the past few articles, I’ve been predicting the dollar bounce. As commodities rally and interest rates follow them up, it’s really inevitable that the dollar would bounce. It’s simply money flow to the highest yielding currencies around the world. As rates rise in the US, money will chase that yield, thereby causing the dollar to move upward. Someone was buying bonds Thursday and Friday, and they need/demand dollars to do that buying with. But like I said, the real key is whether this is a bigger trend turn to the upside or just a little bounce before continuing down. Plan for the former, hope for the latter on the GDX trade. I know I’ve said this a couple times, but if you take this GDX trade, be very careful. It’s a fairly risky trade because it’s somewhat countertrend, definitely a scale in and not a plunge. In fact, it may turn out that there’s actually no trade there at all if the reflation trade is stopped cold by rising rates and a rising dollar. This entire trade depends on the speed of change in the UUP, TLT, SPY and GLD.


UUP – I pointed out the 24.30 level, which established in early January, a few times earlier in the week and price did manage to drop just below that, however there was a huge bounce off that level on Thursday and Friday. The bounce took the UUP from 24.17 all the way to 24.52, which is a significant move in that instrument. The correlation between the dollar bounce and equities selling off should be a wakeup call. I don’t think traders are focusing enough on the dollar and the damage that could result if it snaps sharply back to the upside. The dollar is sending a signal in the larger macro picture, but I don’t think anyone is listening yet. The hardest hit group in a dollar bounce would most likely be the commodity stocks. They have been driven by the reflation trade, however a stronger dollar (and higher rates) are the forces that will eventually stop that reflation trade and limit the upside in inflation. If you want examples of this on the larger scale, just go back and study inflation in the 1970’s and the forces that finally brought that under control. This rate issue is a battle between free market forces and the FED, and this week I think equities might be considering that the FED could lose this battle and higher rates (and QT) could be on the way earlier than expected. Keep and eye on the CAD specifically for signs of change in oil. I posted a CAD chart on Twitter showing the long downtrend that may be in danger of breaking. If that downtrend breaks, that’s probably not a positive for the energy sector. A weak dollar has been propelling this run higher in oil and if the dollar finds a bottom and starts to strengthen, that’s a warning that USO could be hitting a top and begin to weaken. Every piece of information helps.


XLF – One sector that loves higher rates is XLF. As interest rates rise, so does the interest income for banks. This correlation was on full display Thursday and Friday. As TLT bounced sharply, the XLF topped out and had high volume down days, losing about 5% in just two days. If the TLT continues to bounce, financials could continue to pull back. This is an important signal for energy traders. The XLF/KRE have been moving in sync with XLE/XOP and IWM. If banks and energy start to diverge, that’s a red flag for energy. Keep an eye on the financials and see where they find some support. Also, notice if financials start to diverge at all from TLT. Also, one other sector that can sometimes offer clues on rates is the XLU. When rates move up, utilities usually move down, which was the case on Thursday and Friday. Every clue helps in the bigger picture.


Energy XLE, XOP

The macro picture above was not kind to energy this week, but all things considered, it held up pretty well and could still have room to make a run at the 54 level if equities can turn upward again. The XLE is still in an uptrend and was probably even a few points above that uptrend this week. There’s a bit of an upward sloping channel that started back in early November (starting with the vaccine announcement) that runs around 47 on the topside and 42 on the bottom. Price is still above that top uptrend channel, even with the larger equity markets selling off. That’s a strong relative strength signal and the factor that makes me think there’s more upside to 54 left in this latest emotion based run. As for whether the actual fundamentals support this latest run, I still don’t think they do, but when emotion and momentum are in control weird things happen. I think these oil stocks are way overvalued right now, but that’s just my personal opinion. I’ve said this a few times, but this is purely a reflation trade being driven by fast money looking for quick profits. It’s very doubtful that what we are seeing now in XLE is being driven by long term holders. And when fast money decides the party is over, the fall can be blindingly quick. It’s extremely important to know why you are buying these oil stocks. Either you are chasing emotional momentum OR you truly believe in the future of these companies. Are you chasing a temporary, fast money, flavor of the day reflation trade or investing in the long term fundamentals of the oil industry?  Don’t confuse the two.


Let me clear up one thing though. I’m a fairly short term trader. There’s going to be ranges in the XLE where I’m completely wrong, as I was in that 46-48 area. I thought there would be more supply there than there was, however demand chewed through it more easily than thought.  Momentum is a difficult thing to estimate sometimes. I missed a little play in that area, but really not that much. However, once you see that you are wrong, you have to get back on the right side of the market. As you can tell from most of my posts this week, I’m moving a little more bullish on the XLE, simply due to the amount of emotion and fast money chasing the reflation trade. There’s nothing wrong with being incorrect at certain points, but the real key to trading is to adjust quickly. Being wrong isn’t a flaw, but staying wrong is. Always remember if you follow me, I’m trading on a much shorter timeframe than almost everyone else you see on energy Twitter.


So where does energy go from here? I think the answer to that question really depends on what the overall market does this week. The best case is that the TLT finds a bottom, the UUP fades again, the SPY/IWM bounce and then XLE follows. If the IWM can regain 226.50 and make a run at 230, then I think XLE can make a run at 54. The unknown variable for me is how much supply is in that 54 area and how eager are sellers to exit their positions? It’s really the same question/issue that the sector had at the 46-48 level, how much supply is there and can the buyers chew through it? If the overall market starts to look shaky, does that supply get aggressive and start to move down on the chart, specifically moving just inside the latest high around 51? Just consider if you were a longer term holder in XLE, say somewhere from 2016 to 2019. You rode out the crash for some reason and price is now bouncing back and getting you back close to breakeven. You are watching the overall market and you feel like it’s topping on the longer term. What do you do? For the ones that really want out, they are going to drop their selling price and try to get inside the latest price range (51). On the other hand, if the market starts to rip (maybe a blowoff top?) what would you do? You would probably stand firm in the 54 area and wait for price to come to you. The same logic applies to the group of buyers below 40 that wish to take profits, as well as the group of bears patiently waiting to short the sector at this 10 year supply point. This is why I say this week’s action in XLE probably depends much on the SPY.


On Thursday, I posted a ten year chart of XLE going all the way back to 2011. There’s a huge supply level at 54. If you pull back to a 30,000 foot view weekly chart, it looks roughly like a huge head and shoulders pattern with 54 being the neckline. There are probably still a lot of holders in XLE who entered above that neckline. Will they pick that neckline spot to attempt an exit? The key, as I always say, is the math. Buying into a level where there is likely a lot of supply is usually a long term losing bet. I’m not saying that price can’t cut through 54, because it most certainly could. What I’m saying is that the odds just don’t say that’s a positive expectation play over the long run.


The better move if you want to establish an XLE long position now is to wait for a pullback. Entering here around 48-50 gives you at most 6 points of profit if price stalls at that 54 level. The downside could be 8+. Not good odds. The odds of the trade being successful increase significantly with a pullback to the 42-43 area. An entry there produces 11 points of profit at the 54 level, more if it breaks through. The risk on a 42-43 entry is maybe 5 points. You have moved from a trade offering you 6 reward/ 8 risk to a trade offering 11 reward / 5 risk. The odds needed to break even on the former trade are 57%, while in the second trade you only need to be right about 31% if the time to break even. It’s simple math. Quite a difference for just a little patience.


As for the technicals in the XLE this week, I’m watching the 46.25-46.50 area on the downside. That level held three times. If price breaks below last week’s range and establishes there for any decent amount of time, then the pullback could go to that 44.75 point where price jumped on the open back on Monday, February 16. Any drop below 44.75 risks taking a shot at that October 30 VWAP in the 40-41 range, at which point I’d definitely be looking at a long play. On the upside, the first level to watch is last week’s VWAP at 48.75. That price will likely control the action on Monday. If price breaks above it, there’s a fairly easy run back to last week’s highs around 50.50. Any move above that would likely require the IWM and SPY to be moving up sharply, so watch those for further guidance. Again, if the highs break, the level to watch becomes 54-55.


Trading Plan for the Week – My primary watch is the GDX play. I’ll be watching the UUP for the speed of any upward trend and where that trend might stop. If the dollar moves sharply, I’ll be very patient with building the GDX long. I’ve already got a small position from 31.50. I posted on Twitter the longer term plan on the GDX play and the weekly charts that support it. I think the entry on the play is in the 30 area, but if the dollar really does jump, I could see the GDX getting to the 27-28 area on a selling climax. It’s going to be a difficult entry, but I like the reward on the trade since the FED can’t stay out of the market. I’m looking for the GDX to make a run back to the upper 30’s, possibly as high as 40, especially if the larger market has some type of major setback and money rushes to the safety of bonds and gold. Also, there’s a really good chance that I don’t take this trade at all. If I see more signs that tell me the reflation trade is failing quickly, then I might just let this one go. I’ll post the entries on Twitter as I make them.


My next trade watch is a long in IWM. If the market does make that blowoff top, I want to be long something for the ride. I’m watching the 215 area on Monday to start in on a long IWM play to ride that move. If things look bad on Monday or there’s a big gap down, I’ll probably just step aside and watch for further clues. The ultimate plan though is still a short play in IWM after any blowoff move. It would definitely be nice to ride the move up and then flip to the short side, as that would provide quite a big margin of error and allow me to size the short up fairly large.


The last trade on the radar is an XLE long if we get a pullback. There’s an OPEC meeting coming up soon and that could be a catalyst that sends XLE down, although likely only temporarily. I’ll start to get interested around that 44.75 area and would definitely build a big position if price got back in the 40-42 range. I don’t think it will drop enough to start a long play this week, but that’s what I’m watching.


I’m still doing some daytrading, but I rarely post those to Twitter. It just seems to junk up my timeline and mostly confuses people when I trade in the opposite direction of my larger plays. So I’ve found it better to just omit it. I’m always open to questions about it though if anyone wants thoughts on intraday plays or market direction/levels.


That’s all I’m watching this week. Still no individual names right now, mostly just trying to really focus on the macro picture and these larger trends for some medium term swing type trades. Once the market shows a true turn down or clear upward resumption with plenty of room to run, I’ll then move back to individual name plays. Be careful out there and remember, this market can turn on a dime and the quicksand can trap you.  Good luck this week.

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