The Energy Conundrum

From the desk of Tom Bruni @BruniCharting

We've been watching some of the Energy ETFs we track most of this year for potential mean-reversion opportunities on the long side.

We recently discussed for our Institutional Clients an opportunity in the Small-Cap Energy ETF (PSCE), which rallied 17.50% from its 2018 lows before reversing back to those levels again.

The main issue in Energy remains that there appears to be an attractive mean reversion opportunity at the ETF level, but when we drill down into individual stocks there aren't many clean setups...making it difficult to identify what the main drivers of this move higher would be.

Let's take a look.

For the purpose of this exercise, we're going to look at Oil Services ETF (OIH) because its risk management level is the cleanest of the Energy subsectors.

In December prices retested their 2001 lows near 14.00 as momentum got deeply oversold, leading us to believe that a retest of that level with a bullish divergence would occur and create a sustainable bottom in the space. Here we are seven months later and we've gotten just that, except we're not seeing the upside acceleration one would expect from a failed breakdown and bullish momentum divergence.

While it is testing my patience, as long as prices are above their 2001 lows of 14.00 we'd much rather be erring on the long side than trying to press shorts in a subsector down nearly 80% since mid-2014.

Click on table to enlarge view.

Here's a closer look at the "double bottom" that's occurred at the year-to-date lows near 13.00, and while this pattern doesn't confirm until the peak between them (18.75) is broken through, there's no reason to be short if we're above 13.00. What is also really constructive is the bullish momentum divergence and that it didn't get close to oversold during the most recent correction. Could this be a first higher low? Maybe.

With that said, as long as prices are above the 13.00 on the daily and above 14.00 on the weekly, the reward/risk is skewed in favor of the bulls. Shorts have had their time, but at the index level it's tough to justify pressing shorts after the move we've seen over the last 5 years.

As I stated at the top of the post, the issue then is finding individual stock setups with attractive reward/risk AND well-defined risk.

Notice I didn't say OR.

We need both of these factors to warrant getting involved, especially given the lower-probability nature of counter-trend trades.

Now there are a few that stick out, hence this post.

Here's Schlumberger Ltd. reversing higher after slightly undercutting its 2009 lows as momentum puts in a higher low. As long as prices are above 35.40, or 35 if you want to give it more room, then we need to be erring on the long side. If prices break below those levels, all bets are off.

The other thing is that the majority of these stocks are reporting earnings over the next two weeks, offsetting most of our edge by adding event risk to the picture. SLB is the exception.

Sure, we could do a deeper dive into analyst expectations and short interest and sentiment and relative strength across the stocks we're looking at to identify those where there are more factors working for the stock than against it into its reporting date, but even then it's just a guess. An educated guess, but a guess nonetheless.

We're not in that business, so the way reason I'm writing this post is to put this theme on your radar and identify the stocks that could drive/benefit from it in the coming quarters. Once this event risk is out of the way we can assess the playing field and figure out how to move forward.

Until then, focus on the ETFs where there's less stock-specific risk.

With that said, here are the other stocks we want to be watching.