Weekly Energy Equities Review and Market Outlook for April 27 – May 1
Apr 26, 2020 Trading Blog
The market is in a very interesting place right now and my view is evolving with the action. I’m almost at the point where I think the bottom is probably in for SPY. As I’ve written the past few weeks, we are already in the bottoming process for XLE and energy stocks. It feels like the overall market is finished with the virus panic and has now turned toward the process of repairing the economy. If the last two months didn’t kill the market, then there’s really not much out there that can. With the cover and disguise of the virus, the FED has also fixed a lot of cracks that have resulted over the years from their bubble blowing policies. Once the economy gets going again, and with the rocket fuel (both past and future) supplied by the FED, the SPY will quickly be on its way to 400. The hope now is that we get one more pullback to the 240-250 area to get the money in for the ride up over the next 18 months. Things change quickly in this game and you have to adjust your thinking as the facts change. It’s always possible that I get it wrong, or that the virus flares up and causes another shutdown, but all we can do is play what we see right now and protect ourselves through position sizing and stops.
A month ago, I thought we would take one more look at that 200 level in the SPY, but that’s probably no longer on the table. The disconnect between the real world and the stock market has developed into something that I never imagined. I’ve watched this slowly happen over the last 10 years, but I still held on to the belief that Main Street at least had some effect on the market. After seeing the most recent actions of the FED and government during this crisis, it has become apparent that even the little connection that I thought was there really isn’t there at all. Now that the market is totally disconnected, there’s very little chance that the real world is going to take it down again because we won’t see anything in the real world that even gets close to the event that took it down to 219. What could possibly happen in the real world that would take it down to 180-200? Even if the virus does flare back up, it will only do so in small controllable areas and now we know much more, so the panic factor is gone. The only thing that will take the market back down below 200 would be something created from the inside, either a change in the White House or another type of financial crisis. I don’t really see either of those things happening at this point, and even if the financial crisis part does happen, the FED can still fix that by blaming it on residual virus effects, so they have a free pass for at least the next 6-12 months.
Speaking of the FED, the big question for markets is how much more stimulus and QE are coming? I think they still have many tricks up their sleeve. I expect that there will be another round of bailouts and another attempt at fixing some existing cracks from their prior decisions over the last 3 years. I wouldn’t be surprised to see another big jolt to HYG soon. As for Congress, I think we probably get a second round of stimulus checks for individuals, as well as a big infrastructure plan at some point. I feel like there’s also going to be some type of coordinated Congress/FED action to do some kind of program to jumpstart the economy and “get us over the hump”, especially as the election approaches and Trump needs the votes. Still plenty more liquidity to come, but timing it correctly is the issue for us as traders.
At this point, you have to trade the market you are given. We have been given a FED controlled and totally disconnected market which grows more disconnected by the day. Trying to trade that kind of market based on economic principles and fundamental principles just doesn’t work. As much as I hate it, and as much as I completely disagree with what the market is doing, you have to play along and not fight it. I really wish we would see 200 again, because I only picked up about 25% of what I wanted around 232, and I’d really like another shot at that one. This isn’t about being right though, this is simply about making money.
Overall Market SPY IWM QQQ
So, if we now accept that this market is moving even further away from trading based on real world events and what’s happening on Main Street, then what do we look at? The only thing you can trust at this point is pure price action. Sometimes you just have to accept what is happening and forget about trying to explain why it’s happening. It’s like electricity, just accept it and don’t worry about why it works. It’s pretty clear that the why in this situation is FED and government based, but it’s really impossible to trade off that because none of us knows what’s coming next. The FED itself doesn’t even know what’s coming next. So the only thing that is true and honest at this point is price action. It’s the only truth we have and that’s what you have to trade off of.
Monday will be day number 27 in this stock market uptrend. Through all the death, through all the panic, through 26 million unemployed, through thousands of businesses destroyed, price has marched on, day after day, upward and onward. The QQQ is green for the year. The LQD is right back near ATH. The SPY is right back where the great Oct-Feb run started. It’s a critical level for markets and a decision likely comes in the next two weeks on whether we grind to new ATH or if we at least explore a pullback. The points to watch this week will be 287-289 and then the 50 day moving average up near 300. On the downside, keep an eye on 279.50 and then 270-272.
For me, the IWM is the more important indicator this week. This instrument is more sensitive to the US domestic economy and provides a much more quality signal for energy. I posted a chart on Friday showing a pennant type consolidation formation which started back on April 6. That consolidation has coiled very tightly and needs a resolution, which we will likely get this week. Price made a small break from the pattern late on Friday, but sometimes it’s difficult to trust moves at the end of the week as many people are simply squaring up positions. See if that little Friday move pulls back to the breakout point and then reverses strong to the upside again, that could be a great trade setup. The 123 and 125 levels are extremely important this week. The 38.2% retracement of the big down move sits at 124. If the IWM can take out 125, then it likely has room to the 133- 135 area, which is the 50% retracement level. On the downside, watch the 119-120 area, which contains the 8 day ma at ~119.50 and last week’s VWAP ~120. There’s also the lower side of the consolidation I posted sitting around 118.50.
The most important group this week will be the financials. If the market is going to push higher, the financials must participate. This is even more true with the IWM and KRE. The SPY has been trading in a range near the highs, while the financials have been trading in a range near their lows. One of them is not telling the truth. If the SPY is truly strong and stays green this week, there should be some great trades in JPM, C and BAC. I also like MS and AXP. There are several different volatility levels from the high of JPM to the low of BAC that should satisfy any kind of trader and all of these chart patterns have very tight and defined stops where the reward offered on a trade should be at least 4:1.
Last week’s setup for a long trade in GDX worked out well, but I missed it. I was looking for a pullback to 29, but it only managed 29.55 and just never dropped enough to scale in. It closed the week near 34. I’m still watching it, but I’m now waiting on a short trade when it gets overextended. If the SPY continues to show strength and inflation isn’t a problem, then GDX and GLD will lose their attractiveness and the crash will be epic. Keep an eye on the XLF and if it starts to break to the upside, then that’s probably the first clue that GDX is done with its run.
Energy XLE XOM CVX WTI
The energy market continues to show massive strength and a total divergence from oil prices. There is almost no doubt now that we have bottomed in energy and are in the process of building a nice base for an upcoming new bull trend. The buying which started April 17 continued right up to the last hour on Friday. We will get a big decision this week in XLE, as price will probably explore the top of the range in the 36-37 level. I really hope it fails and moves back down into the range to build a larger cause, but there’s a really good chance that SPY is going to have a big up week, which will likely pop the XLE out of the top of the range to explore that gap from 42. I have no idea how far price will get into that gap, but I have no desire to chase it anywhere up here at the top of the range. If it breaks out, then that’s fine, I’ll just let it go and put energy on the back burner for awhile and trade something else. Eventually, XLE will come back to test the 36-37 breakout area from above and provide a longer term entry. There’s just not much value in buying a breakout here on XLE, it’s just too expensive. That doesn’t mean that a long trade here can’t work, but for me the cost of taking that trade is just too much. Expensive trades can work, but you don’t give up too much in the long run by passing on those expensive trades and waiting for a better spot.
While the 36-37 range is crucial for XLE, the range to watch for the major components is XOM 45-47 and CVX 88-90. Those two have to break out for XLE to go anywhere. The issue here is that I’m expecting SPY to have a big green week and those two are major DOW components. When XOM and CVX (which make up 45% of the XLE) get carried up by the index, the XLE has no choice but to follow along. However, if I’m wrong on the SPY call, then XOM and CVX could stall and hold the XLE down, even if the other components continue to diverge to the upside. If you are bullish long term and want to take shot long on XOM, then I’d enter in the 43-43.25 area and put a stop on it at 41. For CVX longer term, you could probably look for an entry around 86 and put an 83 stop on it. If the breakout happens, then the return on those trades could be 3:1 or more over the next 60 days.
As for oil itself, what a total disaster and very cloudy situation. I posted last Saturday to stop using the USO and focus on the actual futures price, which hopefully helped. Although I’ve never traded USO and I simply use it to monitor oil price, I completely took it off my screen, it’s done. I wish they would get rid of all the 3x ETF’s as well. They are all worthless instruments which have done nothing but prey on the inexperience of retail traders. If traders don’t have enough money to trade the single leverage instruments like XLE or XOP, then they just shouldn’t be trading. Tangent, sorry. I also wrote last week not to get hung up on oil price when watching the energy stocks, and energy did in fact diverge from oil price. It’s almost like the oil fiasco didn’t even exist when you look at what energy stocks did. As for oil, I really don’t know what happens with it this week, but again, I wouldn’t be too concerned with it as oil and energy stocks are likely to keep diverging. My best guess on WTI is that we hover around the $17-20 area for most of the week. However, if the SPY really does have a big week, oil and stocks may reverse roles with stocks pulling oil higher.
Trading Plan for the Week – All week I’ve been thinking about putting on a big short in the XLE in the 36-37 area, but I’m not sure about that one now after seeing this week’s price action in the overall market. I’m expecting the SPY to have a big green week, which could pull energy stocks right up and out of the range. The only way I’ll put that short trade on is if the SPY looks weak or if the XLE has some type of news driven gap out of the range on Monday morning. I’m writing on Saturday morning and haven’t seen any news like that yet. If the XLE does gap up to the 38 area on Monday, I’d have no problem shorting that back down to the 36 area to retest the breakout point. All the trade setups below depend on a strong SPY. If the SPY is extremely weak, then all bets are off on the below setups.
The most likely course with XLE on Monday is that we open very close to where we closed in the 34.50-35 area. The points of interest on that open would be 34 on the downside and 35 on the upside. If SPY is green, my first play of the week will be a long on any pullback to 34. It’s an easy trade to stop out if it gets below last week’s VWAP ~33.50. If the 34 level holds, then we almost surely take a look at last week’s high of 35.54, so the odds on the trade are about 3:1.
If the XLE 33.50 level doesn’t hold, then the next spot for a long trade would be the 31.00- 32.00 area. There should be large demand at 31, so stop it out if that breaks. If for some reason 31 were to break, then I would stop trading the long side and move to looking for short trades. If 31 breaks, then there has likely been some news driven reason why that happened, so it’s hard to plan for that.
If for some reason the SPY were to be really weak on Monday, I’ll be looking to short refiners. I posted some charts last week showing rising wedges in almost every refiner. The top side of those wedges held on Friday, but the downside move was coming. My first trade would be a short on PSX at 61.25-61.50 with about a dollar stop. If that wedge breaks to the downside, the reward is likely at least $5, which makes a nice 5:1 trade. I’d try the same trade on VLO at 53.25.
If energy opens strong on Monday and doesn’t offer any type of pullback for a long trade, then I’ll likely just move to the sidelines and go back to trading IWM for the day. I’m just not interested in getting involved long at the top edge of the energy range. Breakout trades just aren’t my thing. For IWM, I’m looking for a pullback to the 121-121.50 area for a long attempt. The next level down from that for a long attempt is 120-120.25.
Outside of energy, I’m going to be trading the financials. I’m looking to get long AXP around 81 with a fairly tight stop. If the market breaks higher, it should easily move to the 86-88 level. My second choice is JPM where I’ll be looking to get in long around 89 with an 87 stop, looking for a run to the 95-96 level. These trades will only be possible if the SPY stays strong, so avoid them if the overall market looks weak.
One other group that I’m watching for a longer term play (30-60 days) are casino stocks including LVS, MGM, WYNN, CZR and PENN. I picked up small positions in PENN and MGM this week both at 13.60 and would like to build these. It’s a hated group right now and it may not fully return to its glory days for awhile, but after seeing the interview that the mayor of Las Vegas did this past week, there’s absolutely no doubt that they are going to open these back up way sooner than most people think. Once the announcement is made to open them back up, the opportunity to buy at decent prices will be gone.
So that’s the plan for the week. It should be an interesting week with some big market decisions coming. Don’t get complacent though, when the market does make that decision, the move could be very fast and go much further than expected. I really expect that we will have a big up week, but you just never know with this market. Stay flexible, position size correctly and use stops. Good luck this week.