Weekly Energy Equities Review and Market Outlook for April 13-17
Apr 11, 2020 Trading Blog
Sometimes the market gives you a second chance, but you only get a short time to make the decision to take that opportunity. As you guys know, I loaded the long term account about a month ago around that last OPEC meeting disaster and before the virus hysteria really kicked in, however I missed it badly. The 1987 type crash in the SPY was something that I was not expecting. My three biggest positions, XLE (about 35% of account), XOP and XOM reached maximum drawdowns of 36%, 40% and 25% respectively. On Thursday, I managed to get out of those at breakeven for XLE, -10% for XOP, and +15% for XOM. The total result on the account was about a 6% loss (caused mostly by small positions SLB, HAL, EOG, PE and MTDR) but I’m back at 100% cash now. It’s always painful to lose, but it could have been worse.
I figure I owe you guys an explanation as to why I did what I did Thursday. First of all, when you make a long term trade plan, you should usually stick with it. I really struggled with that rule this time. Had this account decline been only a sector event, I would have easily just let things play out according to plan. The thing that changed my mind and led me to liquidating the trades was the fact that the world is a much different place now compared to when the trades were put on over a month ago, and I don’t think we are going back to that world anytime soon. As you may have figured out by now, my evaluation of the virus situation is completely different from the position of the majority. It’s my opinion that the total shutdown of the economy was a huge mistake. When I put the trades on, I figured the powers in charge would eventually come to their senses and realize this mistake, but they never did. Once that mistake was finally realized by the market, well, you see what happened to markets. Not to go too deep, but we have completely destroyed our economy and forever scarred the consumer over what amounts to about the number of gunshot deaths we incur in a year. I think the severe decline in markets shows that the shutdown approach was indeed a mistake. The market doesn’t trade on death numbers, it trades on economic numbers (and the FED’s response to them). While the death total may have been small, the economic destruction wasn’t. Anyway, the trades were put on with the thinking that the economy would stay open and energy demand would stay sufficient, but that didn’t happen.
Once the hysteria began and the decision was made to close almost everything, energy demand fell off a cliff, which made my trades very wrong. Once those trades were proven wrong, the next question is whether they are better off exited with the small loss or held at this point hoping for the best. With our current economic condition, I don’t think energy demand is going to come back to the level needed to make these trades winners. I think we are going to find that the media has so psychologically damaged the consumer that it’s going to be very difficult for this economy to recover. Consumers have been terrorized and they aren’t going to travel and the virus fear will never let them return to pre-virus levels. Schools remain closed and so far 17,000,000 people have lost their jobs, with more losses to come. The ones that are still working are mostly working from home. That’s a lot of cars and planes out of use, which is huge demand destruction. How quickly will this demand return? I think it’s going to take much longer than most people think. The reason for these trades just no longer exists.
As for the OPEC supply cuts, I mostly think this was just a dog and pony show with no real meaning. As I write on Saturday morning, Mexico is still holding the deal up, but I think that gets resolved before oil opens. The market made these cuts, not the OPEC members, and they were not voluntary. The fact that Saudi and Russia would absorb the embarrassment of abandoning their positions shows exactly how quickly things collapsed in the world. Everyone finally realized that demand has cratered and nobody was going to buy their oil and that storage space was filling quickly. What else could they do except cut? There’s no way all members will comply, especially if price starts to increase at any decent rate. The cut attributed to the United States was a joke and was merely a market induced cutback. It’s a sad situation when the market itself forces these kinds of historical cuts and probably a good clue of the shape the oil market is really in. I don’t think these cuts help much in the short run, but may extend storage capacity limits for awhile. The demand destruction is just too much. The real question becomes what happens when demand craters further and OPEC has shot its only bullets already? What happens when storage fills? What happens if the demand destruction is greater or lasts longer than anyone expects? Nowhere for price to go but down.
Having considered the fundamentals in the energy picture, the next piece of my decision to exit these trades was the condition of the overall market. The SPY fell from about 340 to about 220 and now we have recovered about half of that loss and currently sit around 278. At this point, you have to determine whether this was just the normal bear market relief rally or if the market is headed back to all time highs. I’m currently leaning toward relief rally rather than new highs. I think the FED rocket fuel is the only thing keeping this market alive and once that wears off and people finally get a look at the final economic destruction, we likely head back down toward the lows, in both SPY and XLE. There could be a little more left to run in this bounce, but I’m satisfied with using this 50% retracement, combined with the hype of Thursday’s OPEC decision, to exit.
Maybe I’m totally wrong and we head back to all time highs, but the hysteria over the virus isn’t going away. We have really only been at this for about six weeks (seems like six years), and there could be MONTHS left to go before it resolves. We may still be closer to the beginning of the problem rather than the end of it. The market is currently pricing a quick end and subsequent total recovery, but I think that’s a mistake. I’ve traded through both the 2000-2002 and the 2008-2009 bear markets and both times the market WANTED to believe things were quickly going to return to normal, but sometimes they don’t. I think there’s a good chance that this 2020-2021 situation could end up with the same result.
After considering the energy fundamentals and the overall market condition, the last piece of my decision was the opportunity cost of holding these positions. The small monetary loss in the account wasn’t the most damaging loss. The real cost was all the deals I missed in other sectors because all my free cash was tied up. If this economy languishes as I expect, energy will be the last thing that comes back. If this market declines again to new lows, do you want to be in the stocks that will make the fastest comeback or in the stocks that will recover last? If I have my choice of buying tech or energy at future new lows, I’m going with tech every time. The decision to exit really hinges on the hope that we are headed back down toward new lows and that the long term account can be reloaded at much better prices. It’s a gamble, but right now I think the odds lean toward the market giving better trades at some point in the future, therefore moving to cash is the correct answer.
So, the above was was my thinking on Thursday and the reason for exiting the energy positions. Only time will tell if that decision was right or wrong. There are so many moving pieces right now that none of us have ever experienced. The final question I asked myself was, “Knowing what I know now, would I get long here at 278 and 36?”. The answer was an absolute NO. I may try the trades again, but it won’t be at this level.
Overall Market SPY
The above paragraphs mostly covered my fundamental view on the overall market. On the technical side, I think we may be reaching the end of this latest run. SPY reached the 50% retracement level and could be headed toward the 61.8% level. While these levels are mere speculation, there is some psychology behind them. Most rallies end between 50% and 61.8%, and this rally may be no different. There’s a level between 285-290 that has been significant over the last several years and there’s a good chance we are headed there. I’m expecting that the market will make a big decision this week whether this was just a bear market rally or the beginning of a new leg up. I’m leaning toward the market reaching a top this week and then turning down late in the week.
One pattern that I’ve found interesting over the years is market action after a three day holiday weekend. It’s amazing how many times sentiment changes over a three day weekend. I’ve never seen any scientific backtesting on this, but it seems that it’s an abnormal amount of times that a reversal will happen after a three day weekend. I’m not sure why this happens. Maybe it is the urgent action and positioning before the three day holiday that causes the unwind of those positions on the next Monday, which in turn leads to more people jumping on that move, which in turn leads to a change in the larger trend. We saw a very large run up ahead of this three day holiday, let’s see if that gets unwound on Monday and lights the fuse to a change in trend back to the downside.
The most important watch this week will be LQD and HYG. The FED stepped in with trillions to prop these up. I mentioned LQD last week and if you look at the jump it made on Thursday it is almost back to new all time highs. The move from 134 to 104 and then back to 132 is just amazing. HYG isn’t too far behind going from 88 to 67 and back to about 82 on Thursday. Keep an eye on these to see if they hold the gains. If they start failing again, that’s a bad sign for SPY.
Also, keep an eye on IWM. I spend most of my day trading IWM and it’s still lagging the SPY by a good bit. SPY has managed to retrace about 50% of the decline, however IWM has only retraced to the 38.2% level. The small cap domestic companies in that ETF are hurting with the shutdown. The American consumer isn’t shopping and they aren’t travelling, so IWM and XLE both suffer. I’m looking for the IWM to possibly get a pop Monday, but likely pullback the rest of the week.
One last thing to watch is GLD and GDX. With all the FED liquidity, these made big moves on Thursday. They might be sending the inflation signal, as well as a signal of a weaker dollar to come, both of which would be good for oil. There’s room for GLD to make it to the 172 level in the coming weeks, so see what happens this week at the 160 level. Price has spent Feb-April trying to break out of that 160 level and will likely take another shot this week. As for GDX, keep an eye on the 31 level to see if it breaks out. If price takes out 31, there is a good chance that it could make a huge run to the 40-42 area. If price pulls back anywhere near the 26-27 level, I’m going to be putting on a long position with about a dollar stop.
SPY closed that early March gap around 274, so see if that level can hold on a Monday pullback. If it does, then there’s a good chance price tests the 286-290 area this week. If 274 fails, then price likely heads back to the 260-263 area. If the 260-263 area fails, then price likely tries to close that gap back down to 250.
Energy XLE XOM CVX WTI
XLE was in the perfect sweet spot this week with SPY making a huge run and OPEC offering the energy bulls hope. Those two forces combined for a 22% move in XLE. The move was +19% for both XOM and CVX. The XOP was an even bigger winner at almost +30% at the high point from the prior week’s close. On Thursday, the XLE reached a gain of about +60% off the March 18 lows. That’s about double the move in the SPY off its March lows. Now that the big OPEC cut is finalized, it might be time for a breather and some much needed consolidation.
Technically, I think there’s a good chance XLE pulls back to the 29-30 area this week, which would be a drop of about 12% from Thursday’s close. That’s a big call, but I think there’s that much hype and rumor priced in already. If the SPY pulls back, we might see the XLE pull back twice as far, just as it did on the way up. At some point, I think people will start to realize the bad shape this economy is in and XLE will suffer a significant move back down. Timing that pullback is difficult though. There’s really just no reason for buying up here in the 35-37 range, as the odds are tilted toward there being more risk than reward. The better option is to monitor the SPY, let some of the air out of the OPEC hype, and see how far XLE pulls back before getting long. If it runs away on the upside, then just let it go, don’t chase.
I’m looking for a pullback in XOM to the 39-40 area and a pullback in CVX to the 75-77 area. As for oil itself, I’m really not sure what happens with it. I do think we could see oil price and energy stock prices diverge this week. I could easily see WTI dropping back to test the 20 level again, but I could also make the case that we reclaim 24 and then consolidate in that 24-27 area for the coming week. I don’t see it breaking above 27, but I also don’t see it breaking much below 20 either. It seems a bit stuck in this 20-26 area for awhile, which wouldn’t be a bad thing. If it can settle out around 24-25, then energy stocks could probably hold in well on the pullbacks listed above. If WTI surprises and takes out 20, then energy stocks could find themselves in danger. It’s really a tough week to predict.
From here on out, I think it’s going to be really difficult to put money into the smaller oil producers, especially the ones with debt. The US has promised cuts in the OPEC and G20 deals and that’s going to hurt. These cuts were probably market forced, but the fact remains that the debt is still there and the revenue probably isn’t coming back. It’s time to move up the quality ladder and stick with the survivors. If you are a longer term investor, then this is absolutely the only way to go. At some point, there will be an oil price spike. It could take a couple years, but the seeds are being sown now and the only companies that will reap the reward are the ones who can survive for a couple of years. I really think the best approach is a position in the XLE. I’d definitely avoid the XOP, there are just too many companies in that ETF which will likely not survive or merely be zombies if they do. One group that may be helped by these production cuts are the natural gas names such as COG, EOG, RRC, SWN and AR. Over the last few weeks, as the oil E&P names cut production, the associated gas production declined as well, and that’s definitely a support for natural gas prices.
I think the group that catches the worst of this whole situation will be the service names. SLB and HAL were the two largest price percentage decliners of the names I bought in the long term account. As many smaller E&P’s go out of business and the larger E&P’s cut production, there’s just no need for services. It’s really going to be painful for the smaller service names and I’m not sure there’s really any chance of acquisitions because the larger service names just don’t need the extra equipment or employees. Also, the major cuts in the XOM/CVX type names have been Permian cuts, so that’s even more pressure on the smaller local service names. The big guys like SLB, HAL, BKR and NOV will survive because of offshore and international work, but the guys focused strictly on North American onshore are probably doomed.
One group that might not be getting enough love is the offshore names. I could make a case where the majors might find this current period a good opportunity to start some offshore projects which could be completed right around the time when oil prices spike up a few years from now as a result of all this capex cutting. The services cost on those projects would absolutely be cheap right now with service names likely willing to do the work for cut rates to replace their onshore revenue. If the majors are committed to production cuts and still have money to spend, why not put that capex money into a project that doesn’t produce now but rather completes around the time that the OPEC production cuts are lifted? I haven’t watched offshore names in a long time (only RIG, DO and FTI), but I think it could be time to research what’s going on in that space to find the quality (least bad) names.
Trading Plan for April 13-17 – I’m looking for a small pop on Monday as longer term investors absorb the OPEC cuts and all the hype surrounding that which is being blasted this weekend on the news networks. I could see price maybe moving back into the 36-37 range for one test, but I think that test fails miserably. Once the top is in and the supply cut hype wears off, then the reality of the enormous demand destruction will soon set in. If OPEC ever has a “demand increase” meeting rather than a supply cut meeting, then I’m all in on energy, but I doubt they ever find a way to alter demand, and that’s what is really in control here.
I cut the 1/4 short position from 36.25 that I was holding on the OPEC pop. Price dropped right into the heart of the Tuesday-Wednesday action and made a good target for a quick 8% gain. So I’m starting fresh on Monday, 100% cash in both the trading and long term accounts. I’m not interested in doing anything in the longer term account this week, it will probably be all short term trading for me.
If we get the quick Monday morning pop, I’ll be looking to get short in the 35.50-36.50 range for another go at that trade. If we open down, then I’ll probably just stand aside and see what happens at the 32.25-32.50 level. If things look weak, I’ll probably try a short play there. Trying a long play off that level is probably not a great idea. Not saying it can’t happen, just that if that level breaks, things could move down very quickly, so it’s really hard to control risk there and I’d probably avoid getting involved long around 32.
The first good long opportunity will come around the 31 level. I could see XLE making an attempt to bounce at the level where it first gapped and broke out on Tuesday. If 31 can hold, there could be a nice bounce back to the 33 level. Taking a long scalp at 31 also gives a fairly concrete stop of about a dollar to control risk very well. It wouldn’t be a huge trade, but you could likely get 2:1 on the money if it works out. That same trade is likely available for XOM around 40 and CVX around 78.
It’s difficult to go much beyond the above plans since the market is just moving with so much volatility. Things should calm for awhile as the FED may be out of the market for a bit and we just sit and watch the virus situation this week. It’s still a dangerous market, so don’t get complacent thinking the volatility is over, because it can change on a dime.
Hope everyone is enjoying the three day weekend. This is one of those times where I wish I could have just saved this holiday to spend later. Not really much use for a three day weekend when you have been doing nothing anyway for the last month. Looks like it’s going to be another day sitting on the deck drinking wine rather than heading to the winery. I miss the live music. Enjoy the rest of the weekend and take care of yourselves, keep the mind peaceful.