I’ve been hearing a lot about this “head and shoulders” continuation pattern lately in the Energy sector. Whether it is or whether it isn’t, I don’t believe is the point here. I think the overhead supply that would be considered the “neckline” in this instance, is the more important level to watch. Here’s what I mean.
This is the daily chart of the S&P Energy Sector ETF $XLE. You can see a left shoulder of sorts in December, the head in late January/early February and then the higher low this month to represent a right shoulder. With the neckline at $88.50, this is the level that chart watchers are keeping a close eye on:
What gets me here is the longer-term chart. Although this pattern is working itself out nicely so far, the upside here, in my opinion, is somewhat limited based on the larger time frame. Here is a weekly chart showing Energy running into all-time highs from 2008. This is where Energy peaked before crashing 60% over the next 10 months.
The market has memory up here. And not pleasant ones. Last time investors bought stock up here, they got destroyed. Literally.
So although this continuation pattern looks okay, it’s hard for me to trust. Perhaps that has something to do with the relative strength in Energy vs the rest of the market. This is one of the more disappointing sectors over the past few years. Look at the relative strength in Energy breaking down this year to levels not seen since 2007. To me, this is a big break:
So if we’re watching the price of Energy trying to break out to historic highs, we’d normally want to see it outperforming on a relative basis. Simultaneous breakouts like this are a powerful combination. We saw exactly that from healthcare in 2012, for example, and look how well that did. We’re unfortunately seeing the opposite today in Energy.
Look at the biggest components in the Energy sector. These aren’t leaders. In fact, Exxon and Chevron are big time laggards. This is not what you want to see as a sector approaches historic highs for the first time in 6 years:
I don’t trust energy here. Even if I do see a breakout above this neckline, it looks to me like the upside is limited. I prefer to stay away and let them prove me wrong. At that point perhaps I’ll consider a position. For now, there are better places to be.
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Tags: $XLE $XOM $CVX $SPY $XLV