From the desk of Steve Strazza @sstrazza
If Bitcoin’s run to $50,000 or the latest YOLO stocks aren’t too distracting right now, you might have noticed Crude Oil just registered new 52-week highs for the first time since fall 2018.
Or maybe you’re ahead of the curve and caught our post about the Energy Sector experiencing what looks like a bullish initiation thrust just a few weeks ago.
Or perhaps you saw Financials just closed the past week at fresh all-time highs… finally breaking out after almost 15-years of no progress!
On top of all this action, the US 10-Year Yield is also pressing on its highest level in almost a year.
It’s clear that more cyclical stocks and economically sensitive Commodities are taking on leadership roles. We’re in quite the risk-on environment.
Considering the evidence we just listed, it’s finally time to address the elephant in the room…
Are Energy and Financial stocks about to lead the market?
That’s right, I said it!
Are these sectors ready to not just keep trucking higher on an absolute basis, but actually show sustained relative strength vs. the broader market?
More importantly, do we want to be buying these groups to express our bullish thesis for stocks?
Today, we’ll look at the evidence and try to answer these pressing questions.
Here is the Large-Cap Energy Sector SPDR $XLE.
XLE is printing a breakaway gap today as it opens the week up about 3% (above data as of 2/12/21). This is exactly the bullish confirmation we were looking for.
Let’s break this down:
Energy stocks have been basing since Q1 of last year, and are just now breaking higher above a key resistance level.
The long-term moving average has flattened out and turned higher, which is evidence the groundwork for a reversal is in place.
Momentum has shifted back into a bullish regime.
Price is currently challenging its highs from last summer. After that, you’ll notice a lot of empty space between current levels and the low-to-mid 50 range where price bottomed in 2018 and 2019.
When these “air pockets” get filled, they often do so aggressively, as these formations behave very similar to gaps. They are simply zones where little-to-no price memory exists. In this case, it was caused by the velocity of the selloff last February as price collapsed to fresh record lows in historic fashion.
As long as we’re above 44, the bias is higher toward 54-57, which is the same level where prices gapped lower from when COVID fears took hold of markets last year.
You can actually see this same pattern (but much cleaner) on the Equal-Weight ETF $RYE chart.
Here’s a look.
Again, notice how the breakaway gap during last year’s crash coincided with this critical support/resistance level. The only issue with this chart is there are only about 4 points of potential upside left back toward these key former lows.
Here is Energy on a relative basis.
This obviously needs more work, but for now, it’s progress. XLE has been rallying relative to the S&P since last year, sparked by a failed move and bullish momentum divergence. That’s more than we’ve been able to say about the space for years.
We’ll dive into a number of the sector’s top holdings below. But for now, let’s hop over to Financials.
We can’t overemphasize the significance of these new all-time highs for XLF. This isn’t like any other bullish development.
Price has remained trapped beneath overhead supply for nearly a decade and a half. In recent years, we saw these tests of resistance become more frequent. It was only a matter of time until buyers took control.
Similar to Energy, we’re seeing bullish follow-through today as Financials appear to be registering a breakaway gap above those critical prior highs of ~31.50.
You can see this in the insert above and the daily chart below.
This is like the setup in Energy with a very clearly defined risk level… only better because price is breaking out to all-time highs.
Above 31.50, and we want to own XLF with a target of 40 over the next 2-4 months.
For those looking for a longer-term target, we can use the extension from the Financial crisis drawdown instead of the more recent base. That gives us a target of 47 over the next year-plus.
But again, only if we’re above 31.
Here is the sector on a relative basis now.
As you can see, the ratio just bottomed out and is trying to reverse higher off a very logical level at its all-time lows from 2009.
We have a bullish momentum divergence on both the weekly (above) and daily (below) charts, and price has been basing constructively for about 12-months now.
If and when Financials resolve higher from this base relative to the broader market, we think we’ll be in for some serious outperformance from the space.
But the more important takeaway is that we don’t need to have a sustained relative reversal in place for these trades to work out. We can’t reiterate the following point strongly enough about both of these sectors…
We still don’t 100% trust Financials or Energy.
I mean, how could we after all these years of underperformance? These groups have literally been dead money… or worse. The definition of opportunity cost.
And we still need to see more data and follow-through to confirm these new trends and/or breakouts. This is especially true on relative terms (*keep in mind, it will be strong potential confirmation if today’s move holds into the close).
Although in a market where everything seems to be working, it becomes less and less about identifying relative strength and more about catching the most opportune risk/reward setups… and right now, the profit potential from these areas is just too good to ignore.
There is room for significant upside as strong moves often follow massive base breakouts like the one in XLF, or occur when price rallies into “air pockets” like we’re seeing in XLE and so many of its components right now (which we discuss in more detail below).
Last but not least, it’s the macro backdrop and weight of the evidence in front of us…
Investors are rushing into risk assets like there is no tomorrow. If there was ever a time for the most beaten-down stocks to make a turnaround, it would be in an environment like this.
We have continued to make the case that we want to be buyers, and definitely not sellers of stocks.
And finally, for the first time in a long time, that even applies to Energy and Financial stocks.
Now let’s take a quick look under the hood to see if the underlying internals are there to finally support a breakout for these sectors… as well as outline some trade ideas.
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Since we left off with Financials, we’ll pick it back up there.
First up is the largest component, Berkshire Hathaway $BRK.B, weighing in at a commanding 13.5%.
The stock has recovered nicely from last year’s drawdown and after consolidating for a few months at its pre-COVID peak, just broke out to fresh all-time highs.
If we’re above 232, the risk is to the upside and we want to own Berkshire with a target of 277 (and secondary at 300) over the next 1-3 months. JC outlined a long idea in the stock earlier this month.
The second-largest holding is none other than JP Morgan $JPM, which we coincidentally happened to get long this week through our Young Aristocrats column. JPM represents about 12% of XLF.
Here’s another look at the weekly chart.
We like it long above the 135-140 area with a target upwards of 210-215.
Considering that’s a 50% move from the largest bank in the US, we’re going to want to give this at least 6-12 months (maybe longer) to play out.
If you’re looking to trade this breakout over a shorter timeframe, we can use the first extension level of the recent base as our target. Here’s a much closer look at the daily chart with these levels outlined.
We think the third time will be the charm for JPM. We can define our risk at the 2020 and year-to-date highs of about 141 and target 181 over the next 2-4 months.
The new all-time highs from these Financial bellwethers, which together comprise over a quarter of the ETFs weight, definitely support the new all-time highs from the sector itself.
Not to mention, we’ve been long two of the ETFs other top holdings, Morgan Stanley and Goldman Sachs, for a few months now and continue to like these names as well.
Now for Energy.
Here is the Energy Sector SPDRs largest component, Exxon Mobil $XOM, with a hefty 25% weighting.
The chart looks worse and worse the further you zoom out. With that said, there could definitely be room for a significant counter-trend rally.
Just like the ETFs above, there is a lot of empty space between those 2018 and 2019 highs and current levels.
If we’re above 50, the bias is higher and we’re long XOM with a target of 66 over the next 1-3 months.
Now here is the other dominant weighting in the ETF. This is Chevron $CVX, which represents an additional 20% of XLE. Chevron is definitely the stronger of these two giant US Oil & Gas conglomerates as it has consistently outperformed Exxon Mobil for over a decade now.
Here it is, zoomed out over 15-years. Structurally, things could be a lot worse… and are for a lot of other Energy stocks.
While this definitely has the characteristics of a massive rounded top, sellers were once again unable to violate key support in the mid-50s during the selloff last year.
As long as we’re above that level, this is still a consolidation within an uptrend. Not to mention, we love it when patterns fail…
Here is a closer look at CVX.
We can own this on strength above the recent highs near 96 with a target of 123 over the next 2-4 months.
Some of the other top holdings of XLE have already reclaimed last summer’s peak, and/or are showing impressive strength relative to their peers.
Not only do we prefer to own these names, but this is important information as it speaks to the health of the underlying internals driving the sector higher.
Let’s take a look at them now. Here’s Apache Corp $APA.
Above 18.50 and we’re long with a target at its pre-COVID peak of 33.75.
Here’s another Explorer & Producer, EOG Resources $EOG.
We can own EOG on strength above its recent highs of 62 with a target of 90.50 over the next 2-4 months.
Notice the nice base on relative terms for EOG as well, as the stock looks to take on a leadership role within the space.
Here is Occidental Petroleum $OXY.
The stock is currently trading just off new 52-week highs on both absolute and relative terms.
As long as we’re above the Q2 2020 and year-to-date highs near 23-24, we’re long with a target of 48 over the next 3-6 months.
Last up, we have the Oil Services giant Schlumberger Ltd $SLB.
Again, we like the outperformance off last year’s lows from this stock. We also like the setup with our risk clearly defined at the year-to-date highs of 26.50 and a target of 41 over the next 3-6 months.
At the end of the day, it’s still too early to call for a structural reversal in Energy stocks on absolute or relative terms.
The same can be said for Financials, even if only on a relative basis. As for the absolute price trend, 31 is the line in the sand — and that’s all the data we need there.
Our ultimate goal here is to point out the fact that bullish evidence has been pouring in for these sectors recently and they warrant our attention.
In many ways, this is as logical a time and place, and as supportive of an environment as we’ve seen in almost a decade for these lagging sectors to make their move.
And remember, it’s not that we’re making a bet on sustained outperformance. This is a risk/reward play. If the relative strength shows up, it will simply be a tailwind.
We still think Tech and Growth look excellent. With the market throwing so much at us, getting long the most asymmetric setups is one of the best ways to take advantage of this favorable trading environment.
As they say, we have to make hay while the sun is shining… And right now, it’s glistening, even on these two secular laggards.