From the desk of Steve Strazza @Sstrazza
Energy has been by far the best-performing sector over the trailing 12-month period.
In October, we witnessed a handful of energy stocks and industry ETFs break higher from bases and reclaim their summer highs.
Without a doubt, these are bullish developments for the space.
But over the trailing month, energy has lost that leadership position and has actually been the worst-performing sector in the market.
Today, we’re seeing a lot of the upside resolutions from last month undercut their former highs and turn into failed breakouts.
So, where do we go from here?
When we look at the relative trends in the energy sector, we get a much different picture than what we’re seeing on absolute terms. Most of them never resolved higher like their absolute trends and simply remain messy, with prices stalling at the upper bounds of their basing patterns.
If we’re going to see sustained outperformance from energy stocks, we need to see them resolve higher relative to the broader market.
Upside resolutions on a relative basis would also act as much-needed confirmation of the new absolute price highs for the indexes.
When we consider the potential failed breakouts in energy stocks and energy futures contracts as well as the weak breadth, bulls will take any confirmation they can get. But it’s just not happening.
Instead, all signs are indicating these new highs for energy stocks aren’t likely to stick, and the group still has work to do before it assumes a more sustainable leadership role.
Let’s start with our recent Mystery Chart, which was the ratio of equal-weight energy versus the equal-weight S&P 500:
We asked whether this rounding bottom would resolve higher and complete a bearish-to-bullish trend reversal, or if sellers would show up at these former highs and reject prices at the upper bounds of this multi-year range…
For now, it’s the latter. This relative trend looks like it needs more time as it just failed at a logical level of resistance.
Let’s take a look at the mid-cap energy index relative to the S&P Mid-Cap 400:
It’s the same story. After making an incremental new high last month, the ratio just failed and undercut its breakout level. Similar to what we’re seeing on an absolute basis, these trends have fallen back into their former ranges. Our bias is neutral until we see some resolutions.
Last but not least, here’s the small-cap ratio:
Once again, we’re seeing prices retreat and print a failed breakout at their summer highs. Range-bound and messy remains the outlook for these relative trends.
And when we look at these groups on an absolute basis, it’s no different. The charts look almost identical, with prices collapsing back beneath their June highs to round out the week.
Seeing all these absolute and relative trends fail at critical levels at the very same time tells us all we need to know about energy stocks right now.
It also paints a bleak picture for other cyclical groups like financials, materials, and industrials. They’re all flirting with failed breakouts at their year-to-date highs as well.
But let’s keep it to energy and recap what we’re dealing with here…
Breadth is collapsing and has been diverging from price rather than confirming the new highs.
The relative trends are being rejected at key areas of resistance.
And we’re even starting to see multi-year bases in energy futures roll over and violate breakout levels.
None of this bodes well for crude oil as it tests our risk level of 76 from above.
We’ll have more details on the action from energy commodities in this afternoon’s post, so look out for it.
The bottom line is we want to stay away from energy stocks for now. The primary trends need more time to consolidate and build up steam before we see these major bases break higher.
We still think this happens over the long run. But over the near term, there are far better areas to put our capital to work. With cyclicals looking vulnerable as a group, we want to focus on other leaders such as tech and discretionary.
Do you agree?
As always, shoot us a note and let us know your thoughts!