From the desk of Steve Strazza @Sstrazza
Energy stocks and Crude Oil have been trending in opposite directions over the trailing three months.
We know these kinds of intermarket relationships can dislocate for extended periods of time, but some recent developments in the space have us thinking it may be time for this divergence to correct itself… and it’s likely to come in the form of Crude catching down as opposed to stocks catching up.
In this post, we’ll reveal this week’s Mystery Chart and discuss what the recent action in Oil could mean for Energy stocks in the weeks/months ahead.
First, thanks to everyone for participating this week. Most of you were sellers. Yes, it was Crude and many of you guessed it!
Last time you’ll get a layup like that…
Crude Oil is not only a very important chart right now, but it also made for an excellent exercise in pattern recognition. Price was coiling towards the apex of a rising wedge, which most respondents identified as evidence to support their bearish view (as opposed to a continuation pattern, which was a question we posed in the Mystery Post).
After failing to break above its recent highs at 43, Crude Oil appears to be resolving lower from the tight range its been trading in for the past several months.
This is a critical development, as whichever direction price heads from here will likely mark the start of a new short-term trend and have implications across many markets.
Here’s the updated chart, with the one-day rate of change indicator added in the bottom panel.
It looks like the market has spoken this week as price just violated wedge support.
Notice the declining volatility since price began trending sideways in June. This is illustrated by the contracting momentum and increasingly smaller one-day moves.
Following a wild start to the year, Crude Oil has been a snooze-fest for a while now. When this beast eventually wakes back up, watch out, because as we all learned earlier this year, moves can happen hard and fast in this Commodity.
With momentum below 50 for the first time since April, an expansion in volatility would make sense here as sellers appear to be taking control. As such, we’ll be watching for downside follow-through in the coming days.
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We only want to be short Crude on weakness below its recent pivot low ~40 with a target at the April high ~28.50. We’d expect this move to materialize on the shorter end of the next 1-3 months.
We’ll also be watching to see how Copper, Emerging Markets, and other assets perform amid any further weakness from ‘black gold’… but the most obvious area that should be impacted is Energy stocks.
If Energy couldn’t catch a bid while Crude was grinding higher over the past few months, how’s the sector going to perform in an environment where Oil is moving lower?
To see what I mean, here’s a look at the performance of the two since Crude began consolidating in early June, which not so coincidentally is the same time Energy stocks peaked.
Large-Cap Energy stocks are lower by -24% while Crude Oil is higher by about +6.5%.
Now let’s look at the daily chart of the Large-Cap Energy Sector SPDR $XLE.
How about that Island Reversal? This bearish exhaustion pattern peaked on June 8th, just as Oil began to lose momentum in its current uptrend and transition into more of a rangebound market.
Sellers have been trying to knock XLE below the 36ish level for over 4-months now, but have been unable to force a sustained breakdown. Buyers have been resilient.
There have been a number of failed moves lower and positive tests of this support level. Although, these are looking a lot less like failed breakdowns and a lot more like false starts lately.
Considering the continued relentless effort from bears, we have to ask ourselves how much buyers have left in the tank at this point, especially now amid the breakdown in Crude.
Notice how the tests are becoming more and more frequent and the rebounds off support are becoming weaker and weaker. This is a sign that sellers are becoming more aggressive.
Here is a ratio chart of Energy relative to the broader market.
Not only is the action from Crude supporting lower prices for Energy stocks, but the relative trend in Energy vs the S&P 500 is sending bearish signals as well.
Large-Cap Energy just made a fresh all-time low relative to the S&P and remains in a strong structural downtrend.
The ratio may appear to have the makings of a failed breakdown, but that’s definitely the lower probability outcome considering the recent weakness from Crude.
When we weigh all these things together, the outlook isn’t good for Energy stocks. If XLE violates its July pivot low of 34.25 we want to be short with a 1-3 month target at the March lows near 23.
If you’d prefer to express this bearish thesis through an individual laggard in the space, you don’t have to look too hard. Here’s the newly former Dow component, Exxon Mobil $XOM.
Not only are we looking at all-time lows relative to the S&P, but Exxon is also flirting with fresh multi-year lows vs Large-Cap Energy (not shown).
The bottom line, Exxon is a perennial underperformer which is exactly the kind of stock we like to short. The risk/reward is also skewed in our favor at current levels.
If we’re below 39 we want to short XOM with a 1-3 month timeframe and target at the March lows of 30.25.
Thanks for reading and please let us know if you have any questions.
Allstarcharts Team