Weekly Energy Equities Review, Market Outlook and Trading Plan for March 22-26
Mar 21, 2021 Trading Blog
The XLE finally got a much needed 10% pullback which left many traders wishing they would have taken profits up at that 54-55 level. I’ve seen a lot of bullish arrogance in energy over the last few weeks. A lot of ‘to the moon’ and ‘$125 oil’ talk, but last week was a reminder that the sector can still bite you if you aren’t careful. It was a good run off the October bottom, but price ran into a brick wall at that 54-55 level on the ten year chart. That level is probably a little thicker than I thought given the pullback so far. Things can’t run straight up forever. The SPY, QQQ and IWM all had rough weeks too. In last week’s article, I discussed how the end of the bull market could be near and this week’s action seemed to support that position. I really thought this market had one more blow off run in it before a major pullback, and it still might, but things looked really soft last week and I wouldn’t be surprised if we got a major pullback soon. If the bulls are going to recover, they need to do it early Monday or this market could be headed down even further this week.
Something seems to have changed after the Wednesday FED meeting and speech. I think there’s some feeling that the lows for rates could be in and the FED free money could slow soon. As the economy gains strength, the FED seems to be acknowledging the fact that their job has been done and they may be more willing to let the economy try to stand on its own feet. The TLT will be an important watch this week. If it keeps falling (and rates keep rising) the equity markets might show some concern and roll over into a significant pullback. On the other hand, if the TLT starts to rise, that could produce a bit of a Goldilocks situation and fuel the final blowoff leg in the bull market. I’m still on the sideline and see no good long or short trades. I’ve planned a few longs if we pullback and also a few short setups if we get that final blowoff move, but mostly it’s just a time to sit and wait for the market to give the signal.
SPY – The SPY made an attempt to break out just after Wednesday’s FED meeting, but failed and topped out at 398.12. Thursday and Friday followed with big down days on solid volume. Something about the FED meeting made a difference in positioning. Last week’s high/low price range is the marker for this week’s action. Will the SPY make another run at the 398.12 high or the 387.15 lows? Look for price breaking out and establishing beyond one of those extremes, with a continuation in that direction.
QQQ – Tech is stuck in a range between 324 and 311 right now and it’s difficult to tell if this is an accumulation or distribution area. The important points for Monday are 311 on the downside and 317 on the upside. If the market breaks 317, that should open another test of 324-325. If price fails up there again, things could get ugly. If the market breaks 311, that immediately opens up 300. The rotation trade from tech to banks/energy is still there, but not quite as strong as it was, it’s getting mature. Keep an eye on the QQQ and IWM correlation.
IWM – Small caps are where I think the biggest short opportunity may develop soon. I’d really like to see that final bullish blowoff leg up toward 250 for a big short play, but I’m no longer sure if the market has that kind momentum left in it. Traders are starting to get a little cautious. The 226-227 level remains the area to watch for directional clues. Price broke that level Friday, but then managed to grind back above it to close at 226.91. Watch the Friday low of 222.95 on Monday. If that 223 area breaks, there’s room to 215 and then 205. On the upside, watch 229.50-230.50 early Monday for any reaction there. If there are sellers above the market, that’s probably where they will first show.
TLT – There just doesn’t seem to be a bottom in this thing. Price gapped down on Thursday after traders had time to digest the Wednesday FED meeting info, but they did grind it up steadily off the 133.19 low to close at 134.77, which is near where price was at the 2pm Wednesday announcement. I think TLT is the most important market signal for the upcoming week. If TLT continues to fall and rates rise, equity markets might have difficulty, although that falling TLT has been a benefit to KRE and XLE. Watch the 135-136 area on Monday, if price fails there, it could then make another move at last week’s lows which might lead to equities failing.
GLD/GDX/UUP – Gold got a big pop off the Wednesday FED meeting info, but then gapped down on Thursday with TLT. As traders grinded TLT back upward, they pushed GLD upward even faster. These two have been moving together since last August and seem to have no intention of diverging. The GDX long trade continues to perform well and topped out around 34.50 before closing at 33.83. I’d need to see 36-37 before saying that the trend has changed from down to up. Right now it could go either way. It’s been a good move in GDX, but the bigger trend since August is still down.
The UUP is probably the second most important watch (after TLT) next week. It has been building a base and could be getting ready to break upward to the 25.40 area. As rates continue to rise, the world chases that yield which will inevitably strengthen the dollar. A strong dollar is a bit of a headwind for GLD and USO, as well as other commodities. As GLD and TLT gapped down on Thursday, UUP gapped up. The immediate moves after Wednesday’s announcement was GLD moving up sharply with the dollar weakening. Watch the GLD/UUP correlation this week and any effect that has on GDX.
XLF/KRE – As rates keep rising, so too do the financials. This rotation out of tech and into banks/energy continues to hold, but I’d be cautious with that correlation going forward. That rotation trade is getting very mature. If banks start falling, that’s a good warning signal that energy may also fall further. The KRE also represents a big portion of the IWM, so the TLT/KRE correlation is also good information about which way IWM should be trending.
Energy XLE/XOP/USO
In last week’s article, I wrote that it was time to lighten up in energy at the 54 level. That turned out to be good advice as the XLE closed the week about 10% lower at 49.53. That 54-55 level on the TEN YEAR chart turned out to be very thick. But that call wasn’t about being right or wrong with regard to the XLE direction, it was mostly about not risking a big downside for only a small upside reward. At 54-55, there just wasn’t much reward left on the upside, maybe 4-5 points. Well, the downside is already 5 points now with the possibility of growing even larger. I’ve made this point a few times with energy up at these levels, but risking more than you can make on a trade isn’t a very good long term trading strategy. Trading isn’t about being right or wrong, it’s simply about math and getting good odds on the bets you are putting down. Nobody knows which bets they will win, that’s why they all need to have a positive expectation to show a long term gain. Anyone buying above 50 now has a very difficult decision, take the loss now or risk a much bigger loss if the market turns down? And how many of those traders who got long above 50 will sell out breakeven if price gets up there again? Would have been a much better move to accept the math, take the profit up at 54 and wait for the pullback to try the trade again.
So where does energy go now? The upside still has some big problems. That 54-55 level is THICK. There are many older holders from 2009-2020 still sitting just above 55 and we saw exactly how thick that level was on the last test. The question now is do those sellers get more aggressive and come down to the 50-52 level to try and escape? In addition, now we also have some current bagholders that purchased in the 50-55 area who are probably going to be sellers if price moves up 10% and let’s them out breakeven. And do the current bears also show up to sell/short that 54-55 level on the next test? What about the buyers from October 2020, are those guys done taking profits or are they also going to be sellers if XLE takes another shot at 54-55? What you now have is 4-5 different groups who are all sellers targeting that 54 area. XLE has added even more supply to what was already there. I’m not saying that price can’t get through 55, but it’s getting really crowded with sellers up there.
The real problem for energy is if TLT continues to fall (rates up), the UUP decides to break to the upside and SPY/IWM both fall. That situation just brings out even more sellers in addition to the ones mentioned above. Not only will there be more sellers, if the overall market starts to roll over, those sellers will get way more aggressive. The XLE is sitting in a very dangerous situation. I still don’t think it’s time to get long XLE yet, but a long play could develop if there’s another sharp move down toward 45-46, or even as far as 42. I also wouldn’t short XLE, as any snap back toward 54-55 could be sharp. We’re just kind of in no man’s land right now with energy.
One concerning thing I’m seeing on Twitter is many posters claiming that the bullish thesis is still intact because the fundamentals haven’t changed. To this I would say, “What if the recent move up in XLE wasn’t so much due to fundamentals?” If the move up wasn’t based on fundamentals, then does it really matter whether they have changed or not? No, it doesn’t. I’ve tried to make this point several times that there are two (or more) separate drivers in energy, fundamentals and rotation/momentum. So many people don’t seem to notice the difference. If you don’t know the difference, then how will you ever know when to exit your trade? All these guys are leaning on the fundamentals, yet the XLE just dropped 10%. If XLE price continues to drop, then how long are you going to lean on those fundamentals (which aren’t the primary price driver), to make your exit decision? What if this entire move up in XLE was simply a faster money rotation/momentum trade rather than based on fundamentals? I think there are many looking at fundamentals when they should be looking at rotation/momentum. That blind dedication to fundamentals could cost them all their profits before they realize this move wasn’t about fundamentals at all. KNOW WHY YOU ARE IN ENERGY STOCKS.
In the bigger picture, the XLE still hasn’t recovered the February 21, 2020 pandemic start date. Energy is still a laggard in the overall market picture. I’ve said this a few times, but buying the laggard and hoping it catches up to the rest of the market isn’t the best trading strategy. You are buying relative weakness when you should be buying relative strength. You know what goes down first (and usually the most) when the overall market turns down? Yep, the laggard. What if we look back in six months and find this entire energy move was nothing more than a dead cat bounce in the bigger picture? It’s possible. Don’t get tunnel vision into the lower timeframe charts. Focusing on the bigger picture can really keep you out of traps.
I’m still not buying all the Twitter hype on energy, there’s just too many people on the long side of the trade and they are all talking up their own supporting narrative. The companies all still have their usual, long standing problems. Debt, burdensome dividends, bad management, low to no cash flow, ESG competition, political headwinds, etc. In addition, it’s more than clear that a good portion of this oil price rise is solely due to OPEC manipulation and fast money chasing a reflation trade which might be maturing. It was fun while it lasted, but it’s getting late and the party could end soon. Ok, that’s enough bearishness and buzzkill in energy for now.
Trading Plan for the Week – Having said the above, I’ll be watching this pullback in XLE. If it drops into that 45-46 area, I may try a long play depending on how the overall market looks. If price drops to that 45-46 level, I’ll evaluate to see if there might be a chance at 42. As I said before, energy isn’t about being right or wrong, it’s about finding spots where the odds offer enough reward to make the risk worth it. I hate a long XLE play above 50, but I’d have no problem putting down a big bet in the low 40’s. It’s not about what I think about the future of energy, it’s about what kind of odds I can get on that bet, because honestly, none of us know where energy is going.
I’m watching 226 in IWM for any chance I can put on a long play to capture any bullish blowoff leg toward 250. If this market does make one more final run, I want to have something to ride the wave with and IWM is probably the best ticket. Action in the 226-230 area will be telling this week. In the bigger picture, I’m waiting for a short play in the 245-250 area.
Still watching XRT for a short play, but GME has lost all momentum and I don’t think there’s enough value in the short play without GME. I expect that the Robinhood/Reddit crowd is getting their stimulus checks and their favorite target has been retail. All I can do is wait to see if they return to their retail favorites which could push XRT toward 100 for a nice short opportunity.
GDX is probably in s spot where it’s time to lighten up. I’d like to see a move toward 36, but not getting greedy. The bigger trend is still down, so it may be a situation where lightening up and waiting for a second play on the long side after a pullback is the way to go.
ITB is back on the list for a possible short play. It got as high as 67 and I probably should have started a scale in there, but I missed it. If it makes another move on 67-70, I’ll be interested in trying a short. The ITB play really depends on which direction rates go. The housing sector really depends on those low mortgage rates and if those disappear, the sector could take a hit.
SMH and XBI are also in interesting positions. Both have the possibility to break to the upside. XBI needs to take out 150 and SMH needs to take out 242. The XBI corrected about 26% at its lowest, while the SMH was down about 17%. These two have been leaders on the way up, so see if they make an attempt at regaining that leadership on any blowoff type market move in the next month or two.
The CAD is on the radar for a currency trade this week. I’d like to see it make one more dip to the 1.2400 level to long the USD/CAD pair. If the UUP does make that final base and start trending upward, the USD/CAD pair would be primed to break a very well defined technical picture. If it starts a new uptrend, that could be a negative correlation signal for USO.
That’s all I have for this week, mostly just playing the waiting game right now. Sometimes the market just isn’t in a good trading position. I’m cautious because I really think this bull market is close to the end, but I’m also hopeful that there’s one last run before it all ends. Good luck this week.