Weekly Energy Equities Review, Market Outlook and Trading Plan for September 8-11
Sep 7, 2020 Trading Blog
The market finally had a much needed correction last week and may be getting ready to make a sharp move upward in what could be an incredible meltup. The correction was strictly a Nasdaq and tech event and was likely caused by option action unwinding. The endless call buying loop that has been pushing the FANGs straight up finally hit a bump and got thrown in reverse for a few days. I expect that an equilibrium point will be hit this coming week and the positive call buying loop will start again thereby taking the SPY toward 380-400 in the next few months. The ultimate correction is coming, but I think we still have a few months of uptrend left, especially with the stock market being such an important tool in the upcoming election. If Trump wins, we probably get a celebration rally, but after that I think reality might set in some time in December/January for a big move down.
Many traders seemed really worried about this SPY pullback, but the index did exactly what it should have done. It broke out from the 339 level in mid-August and dropped right back down to test that breakout point, which is completely normal. This was a fairly easy short trade call. I took a pair of shorts on QQQ at 303 and SPY at 358 looking for the pullback to the breakout point and they worked out well. The only problem with this type of trade is the timing. I was going to scale in slowly up to QQQ 310 and SPY 365, however the market pulled back too quickly. Getting size in on the short was difficult because there just wasn’t any structure overhead. The only concern with the pullback was the speed with which it happened. I would have liked to have seen a little smoother and slower pullback to the 339 level, but the test still accomplished the same thing. If the bull market is going to continue, the bulls need to step in at 339 and start a new leg up. If the SPY does start that leg up, the next point of concern is 359. The bears will be waiting in the 353-359 area for their next battle. If the SPY can’t make 359, that could put in a lower high and then turn back down for a second battle at 335-339.
The real danger for the SPY is a lower high around 350-353 followed by a breakdown of 335. That would likely set a longer term leg down in motion which could go as far as the 300 area. However, I think the most likely scenario is that the bulls step in this week, drive the market to the 355-359 area and then consolidate it sideways there for a few days and then make a sharp move past 359 for the meltup into the election. This correction shook out so many weak hands that there probably isn’t much supply to stop this market from reaching the 380-400 area in the coming months. Right now, everyone is conditioned to blindly buy the dip and I don’t expect that to change anytime soon.
The selling this past week was really confined to the Nasdaq and the tech names. Almost all of the major components went right to their 50 day moving averages for a test and nearly all of them passed that test with a bounce. Keep an eye on the 50 day moving averages in all the FANG names, as well as the QQQ itself. The only time I would really start getting concerned is if these names all put in 3-4 closes under their 50 mas.
While most people watch the SPY and QQQ, I depend more on the IWM for clues about the energy sector. I’ve been watching the 158-160 area for a few weeks hoping for a breakout, but it has clearly stalled. I think the energy names will continue to move more closely with the IWM than with the SPY/QQQ, therefore energy really needs the IWM to take out the 160 level and make a run toward the highs around 170. If the IWM takes another shot at 160 and fails, that could be the final chance at a breakout and a down leg could then be set in motion. Just like energy, small caps have been underperformers. I was encouraged that the small caps managed to run right to the 50 day moving average and bounce, just as the QQQ and tech names did. If it starts down again this week, the 50 ma at 149 and the 200 ma at 146 will both be important support.
Energy was a difficult sector to read this past week. With the type of SPY/IWM collapse that occurred, I would have expected XLE to easily take out that 34.50 level, yet it held and closed at 35. There was a bit of relative strength there. Financials also showed relative strength and it seems like money was rotating from the best performing sector (tech) to the underperformers like banks, energy and industrials. The real question is what happens when the tech call buying loop returns and money starts flowing back to the Nasdaq. If the rotation stops, do the financials and energy revert back to their relative weakness? If the rotation to energy stops, does the XLE take out that 34.50 level and slide to 30-32?
The deciding factor is probably the WTI/XLE correlation. Oil had a really bad week and is likely leading the energy stock names. The rotation money was enough to keep the sector equity names even, but when that vanishes these names probably follow the commodity down. Energy is really in a tough spot right now. I’d love to step in and try to buy this 34.50 level for some longer term trades, but the failure could easily cause a very quick 10% drop. On the other hand, there’s always the possibility that there just aren’t anymore sellers out there and the 34.50 level is the bottom. The fact that WTI fell and the stocks held tight could be a signal that the sector is ready to run when oil bounces. It’s really just a tough read on what’s going on here as the sector could go either way.
While the next major XLE move is a tough prediction, it’s a great shorter term trading opportunity. I have no idea which way the next large move from this 34.50 area will be, but the trading setup is very clear and should be fairly easy to hedge. I’m probably going to be trading from the long side this week and using the XLE 34.30 area as my stop for the sector and names. I usually have a trading plan going into the first day of the week, but this week I’ll probably just be watching on Tuesday to see how the money flows with traders returning as the summer officially comes to an end.
One important thing to watch this week is the dollar. The correlation was strong with stocks down and the dollar up. The UUP had a nice uptrend all week and could be carving out a longer term base in the 25-25.25 area. I watch the USD/CAD pair for clues on oil and it attempted to bounce off the longer term demand around 1.30, but faded on Friday. See if that pair starts upward again and correlates to a continued fall in WTI. Also, keep an eye on GLD for clues on future dollar direction. GLD had a tough week with UUP moving up and the inverse correlation held firm. GLD is sitting on an important level around 180 and if the UUP does form that base and start an uptrend, GLD (and GDX) could make a sharp move lower.
Energy Names
I think the name I was most impressed with this week was XOM. I’m definitely ready to step in and take a shot long on this one. The action Tues-Fri was clearly signalling a bottom with the tight ranges each day on moderate volume. If XOM gaps down Tuesday or if it forms some tradable pattern under 39, I’ll probably step in and get long. CVX showed a similar pattern, but now I think there’s a difference between the two that some may not appreciate enough. XOM recently got kicked out of the DOW30, yet CVX is still a component. CVX seemed to get caught in the indexing and followed the average down, while XOM was free from this weight and could move without being weighed down by index selling. There isn’t a huge amount of money tied to the DOW anymore, but every little bit of avoided selling helps XOM. However, it’s also possible that this could work in reverse when the DOW30 starts climbing again. As for quality, I probably still like CVX a little better than XOM. I’ll be watching the 80-81 area for a long opportunity.
The one major that is concerning is BP. I’m not sure what’s wrong with that one as there seems to be no floor at all under it and it closed at the lowest level since the March collapse. I’m watching for a longer term entry, but I really have no idea where the bottom is and will wait on a trade until something concrete develops. Same analysis for RDSA.
In the E&P space, the larger names of COP and EOG are getting hit harder than the smaller names. I’m getting interested in COP but there’s just no structure to create a trade off of yet. If this one falls another 10% down to the 32-33 area, I’m probably going to start a long position, even without any tradable structure. Same thought for EOG if it gets to the 38 area. HES is also getting interesting in the 44-45 area. OXY is tempting down under 12, but man I just hate that company so much that I just can’t pull the trigger on that trade. It would probably take 10.50 to entice me into that name.
CXO is my favorite Permian name and it’s setting up for a great long trade around 48. PXD is also holding up well, but I’d need to see 90-91 to get long in that name. The one Permian name that seems weak is FANG. I like this one, but it seems to be following the COP/EOG pattern more than the PXD/CXO pattern, which indicates relative weakness. If the sector breaks down, this one could be the sharpest falling Permian name. PE at 10 and MTDR at 9 could also be good long trade points if energy finds the bottom at 34.50.
Outside of the larger E&P’s and Permian names, I don’t really see too many decent E&P trading setups. The only trades that might be available are DVN in the 9-9.50 area, APA around 14 and CLR around 15.
I’m also starting to like the refiners at these levels. The group of MPC, VLO, PSX and HFC are all sitting on tradable support and could be getting ready for a bounce, especially if oil prices come down to the 35 area based supply rather than demand issues. I’m mostly watching the subsector for short term trades, but this is a group that could easily turn into a long term hold if they see big demand. The trade points for these are 58 for PSX, 50 for VLO and 33 for MPC. I’m a little cautious on HFC and it doesn’t really have any concrete structure until 20, but the reward in that name is always huge so I’ll be playing it with the group.
I’m not seeing much to trade in the services group of SLB, HAL, BKR, NOV and HP. The only trade that I might attempt is a long in HP around the 13-14 level. I like SLB, but it’s just locked in such a small range lately that any trade is probably going to be dead money and definitely not enough reward for the risk required. HAL has had the best run of the group, but it’s probably expensive now and has no real structure underneath to trade off of. One services play that I listed a couple weeks ago was WTTR. It gave me a great entry around 4.35 and I completely choked and missed it. I’ll be watching this one again and would love a quick pullback to around 4 for a long term trade.
I still have absolutely no interest in trading the natural gas names. UNG had a nice bounce off the bottom, but seems to have stalled out around the 14.50 level. I’d like to see a pullback under 12 there to get interested in these names again. If I was forced to trade a name out of the group, it would probably be EQT long in the 14.50-15 area. It has formed a nice base around 16 which was a major area last summer. It has taken a couple shots at 16 and now seems to be forming a bit of a cup and handle structure or falling wedge during the month of August and could be getting ready for a breakout over 16. Watch the 50 ma around 14.35 for a possible setup.
One area that I’m starting to take a look at is coal. Don’t laugh. These names have been off my radar for a couple years, but some of them are starting to make some really defined bases and this fits into a theme I’ve been watching concerning commodity companies that may benefit from inflation. The best setups in the group are BTU, SXC (more steel related), CTRA, CEIX and ARCH. I’m not ready to get long yet, but these are on the watchlist.
Trading Plan for the Week – I’m probably on the sideline on Tuesday. I have absolutely no idea which way this market could go and making a trade plan for Tuesday is probably just useless until the Monday night open. This thing could easily gap big up or down. The initial plan is to watch the XLE for another test of the 34.50 level. I’d like to see that happen early Tuesday morning with a reversal to the upside off 34.50. The one thing I don’t want to see would be a big gap up and then an all day grinding failure back down toward 34.50. That would probably guarantee the rest of the week being negative. I’ve covered most of the energy trades above, but I do have a few non-energy ideas this week.
One theme I’m watching is for long plays in areas where the names have pricing power with an increase in inflation. Basically, names that produce a product where inflation will allow them to charge more for their products. Things like agriculture (ADM, CAG), consumer staples (PEP/MO/MCD/KO/KR), metals (XME), chemicals (DOW/DD/LYB), food (TSN/HRL/K/KHC/MDLZ), etc.
JNJ – This one is either setting up a big triple top or it’s getting ready to break to the upside. It got a nice pullback to a very tradable long entry in the 148 area for Tuesday. I’d stop it out under Friday’s 147 lows and give it a chance to take out 156 on the upside. Be careful with it because if this really is a triple top, it’s going to come down fast when it fails.
PEP – I’ve posted on this one a few times and have been in and out of this name over the last two weeks. Like JNJ, it has pulled back to a nice entry around 137. Use the same plan here with a stop under Friday’s low or even below the 50 ma around 136. There’s a good chance it makes another run at 145. If you like lower volatility trades, you could also put the same theme trade on in KO around 49.25.
V – Same theme as the trades above. Visa has pulled back exactly to the 200-202 breakout area and could bounce to new highs. Look for a long entry around 201 and cut it if it breaks back into that 188-200 range, specifically below the 198 5oma.
MCD – Good chance this company breaks to new all time highs as the virus fears continue to keep smaller restaurants closed. If AAPL can be worth 2 Trillion, there’s no reason MCD can’t at least reach 175 Billion.
TAP – Another consumer play long from the 37-37.50 area with a stop under the 50 ma around 36.50. Looking for a 39 breakout and possible run to 42.50
TWTR – I wish I would have seen this one on Friday. I probably would have picked up a starter around the 38.50 low, but maybe it gives another chance this week in the 37.50-38.50 range. I like this one for a longer term play when tech starts running again. It was just about to really explode before the tech pullback and should be primed for another run at 44.
WKEY – This has surprisingly been my most profitable stock over the last two months. I’ve played it twice and I’m currently building a third position on this tech pullback. I played a run from 7.70 to 11 and then a run from 10 to 11.50. I started the current position at 8 and I’m looking to scale in if price starts back down toward 7. If it takes off from here, I’ll be looking to sell around 10.25. It’s a very small float low volume play, so be cautious.
X – Another commodity play that fits the inflation theme. Looking to get long above 7.50 for a breakout of 8.25 and a run toward 9. Great setup for a tight 25 cent stop and a 1.50 reward.
As you can see, I’m fairly bullish going into the new week, but there’s also a good chance that I’m completely wrong and this whole thing falls apart and we get a big pullback. While the Republicans would love to see this market run, the Democrat backers would love nothing more than to crash it into the ground and use that against Trump. Those kinds of hidden agendas just aren’t viewable on a chart and can be surprise events that you can’t see coming. I’m bullish and will be trading from the long side, but I’m not going to be putting in big size and my stops are going to be VERY tight. This could be a great meltup opportunity, but every reward comes with a proportional risk. Be careful out there.