Weekly Energy Equities Review, Market Outlook and Trading Plan for August 2-6
Aug 1, 2021 Trading Blog
I haven’t had much time to write over the summer, but life is getting back to normal after a couple months of high school graduation activities and family vacations. Time to get back to trading. I’m going to start this writeup with the macro picture and the inflation trade and then move to energy.
The inflation trade, which started back in November, seems to have found its top, at least for now. While pretty much everything has risen together, on many days money has specifically flowed from tech (QQQ), bonds (TLT) and the dollar (UUP) to small caps (IWM), banks (KRE), metals (XME), gold (GLD) and energy (XLE/XOP). If you were to use just those variables, it’s been easy to determine risk on/risk off in the inflation trade, and the market in general. The profitable trade each day has been to long energy when the rest of the macro factors pointed to risk on. Intraday trading has been fairly straightforward, but longer term plays have been more difficult.
This inflation trade has pulled back over the last month and the question now is where does it stop? I think we are going to get some big clues this week. My guess is that we aren’t yet close to the bottom of this latest pullback and Covid politics could derail things. Covid is no longer about health, it’s about politics, power and money. The inflation variables of XOP, XLE, XME, KRE and IWM all look like they topped out last week and could roll over hard this coming week. The areas to watch are XOP 86, XLE 51, KRE 65, IWM 224 and XME 46. I think we might get a test of those levels early in the week. If they get rejected, the sellers could show up in force. On the other side of the trade, watch QQQ 366, TLT 150 and UUP 25. If money runs for the safety of megacap tech, bonds and the dollar, that also suggests the inflation trade is headed down. I’m getting the feeling that it’s going to take a bit of a capitulation type move to bottom this inflation trade and reverse it back upward. That move could provide a great entry for longer term plays. It’s not clear yet where those low points might be. Here’s a quick look at each and some levels to watch this week.
SPY – The only level that really offers information is last week’s high of 441.80. I expect price to test it early Monday morning, which will set the direction for the rest of the week. On the downside, watch last week’s low of 435.99. In the bigger picture, 420-424 is the lower area to watch for chart damage. If that level breaks, a correction could be starting and a break back under 400 is possible.
QQQ – This is the one area you don’t want to short. I think this becomes the safe haven in any market correction, and while it might pullback, it’s probably going to pullback less than SPY and IWM, and when it hits a bottom, the bounce back can rip shorts. Watch last week’s high of 368.89 to see if it tests simultaneously with SPY.
IWM – This is where the market weakness is showing. Smallcaps are lagging badly in the short term. The 224-226 area has been a significant level throughout this entire range that started back in January and it again rejected it on Thursday and Friday. Watch to see if that level gets one more test early in the week. If it fails, price could easily move back down to the bottom of the range around 210-212. The scary situation is if that level breaks and price dips below this six month range. Do the sellers throw in the towel or do bigger players step in and clean up any supply underneath the range, thereby shooting it toward 250?
TLT – Bonds have actually been fairly stable since last week’s FED meeting, but they are sitting at an important level in the uptrend that started back in May. Does TLT break above the 150 level or does the uptrend fail and sink back toward 140? I’m really not sure on this one. If it breaks upward, banks and energy are going to take a hit, therefore TLT is a primary watch this week. In the bigger picture, there should be significant supply sitting 154-156 to cap the upside.
UUP, USD/CAD – The XLE bottomed back on July 19, which happened to correspond with a top in UUP on the same day. If the dollar strengthens again, it’s going to be a headwind for energy stocks. The UUP level to watch is 25.00-25.20. For the USD/CAD, watch the 1.24 and 1.23 levels on the downside and 1.26/1.30 on the upside.
GLD, GDX – The decline in the dollar that began on July 19 has also helped GDX. There was a great trade around 33, but I got greedy and was waiting to see if GDX would break down toward 31-32 and missed the long play. The 35-35.50 area will offer some macro picture clues for the inflation trade, but there’s really not much trading opportunity in GLD or GDX right now.
XME – The metals made a huge run last week from ~39 to ~46. They were helped by a weak dollar, and the action showed some relative strength for the sector. If you want to gauge the volatility of the inflation trade, metals are the area to watch. Look for clues around the 41 level on the downside and 47.50 on the upside. I’m not interested in trading XME anywhere between those two points.
KRE – The banks are still showing a solid correlation with TLT and rates, but that correlation did have a few days last week where they diverged. If TLT starts down this week and the banks don’t react upward, that’s going to be a warning for energy. KRE should test the 64-65 area early in the week, so watch the price action there.
In summary, these variables control the bigger picture environment for energy and this bigger picture should control the direction of energy stock trades. Try to avoid trading counter against this inflation macro.
Energy, XLE, XOP, USO
I know I keep kicking this dead horse, but the fundamentals for energy stocks just don’t matter right now. The oil versus oil stock argument is worthless. The only thing that matters right now for energy is the unwinding of the rotation that started back in November. Inflation is the theme that is controlling, not oil or oil stock fundamentals. At some point, fundamentals will matter again, but that time isn’t now. I see a lot of Twitter gurus leaning heavily on fundamentals, which tells me immediately that they really don’t understand the current bigger picture. I’m sure you have all seen Energy Twitter’s biggest Permabull cheerleader constantly pumping fundamentals, and there’s a whole crowd of his sheep that are trying to make themselves feel better in the short term about their sinking long positions by leaning on fundamentals. He might be right in the very long term, but these guys are losing some significant money over the last month with that approach simply because they have tunnel vision and are ignoring the bigger picture. It will be interesting to see how much permabull guru finally loses and where he throws in the towel.
The technical picture for XOP and XLE is very clear. There’s major supply sitting above XOP at 86 and XLE at 51.50. Those are the two points to watch this week. The bulls might get one more test of those levels this week and if they fail price is likely headed back toward 47 for XLE and 77 for XOP. One note on XOP, the natural gas stocks really caused some divergence to the downside last week, so keep an eye on that group if XLE and XOP diverge again this week.
As for the actual commodity, USO, there should be big test in the 51-51.50 area this week. Keep an eye on the dollar, specifically the USD/CAD pair for clues. If the dollar reverses course and starts to strengthen again, there’s a good chance that could put a top in for oil. Also, watch the metals (XME) for clues since they have been moving strongly with oil. Just remember, the commodity and the underlying stocks are two separate things. I’m seeing a lot of guys fighting the oil stocks because they think they should be rising just because oil is rising. That just isn’t the case currently, so don’t fight it.
Majors – I didn’t dig too far into the earnings reports for XOM and CVX that were released on Friday, but the one thing that stood out to me was the emphasis on buybacks, debt payment and dividends. When you see companies pumping those items, it’s usually because the underlying business sucks. For many, the dividend is the only reason they hold the stock. When companies start selling investors on things that aren’t directly business related (like oil production), you have to ask yourself why. I also saw that both are again planning for less Capex spending. LESS money spent on the basic business of drilling for oil, yet MORE money spent on buybacks? That suggests to me that they really don’t believe in the longer term merits of this oil price run. Maybe that’s partially the reason both were down big on Friday after earnings.
E&P – COP is going to be a watch for me this week. Feels like a decision is going to be made around 58-60 in this one. If it tops out there, the rest of the group will follow. EOG and PXD are showing some relative weakness against COP. Watch the 150 area for PXD and 75 for EOG, there will be clues given off by the price action at those points.
Natural Gas E&P – EQT and COG got crushed Thursday and Friday. I came very close to picking up some EQT around 18, but passed on the trade. If the sector corrects in the coming weeks, I’ll be very interested in the 14-16 area. COG might present a long play sooner than EQT. I’m watching the 15 area for a possible play, depending on the bigger sector picture.
Services – Of all the services stocks, SLB has the most dangerous chart. The 30-31 area seems to have large supply sitting overhead. The chart is setting up in a head and shoulders type pattern. If price rejects again around 30, it should then move toward 25-26 for a big test of that neckline on the H/S pattern. Again, I don’t put much faith in patterns, but the underlying logic is there for SLB. I’m watching the 18 level in HAL. If it drops to that area, I might put on a long trade there, again this depends on the larger sector picture.
Refiners – Refiners are taking the biggest hit in the energy sector lately, but they did have some good bounces last week. MPC is my favorite of the group and I’m watching the next pullback to the 51 area for a possible long trade. One caution on these, the summer driving season is quickly coming to an end, and that end might get accelerated quickly if Covid lockdowns start reappearing. September starts flu season and the overreactions and fear this year will be insane. The media created this inflation trade on the vaccine announcement back in November, and they can kill it just as quickly if things go south this fall.
Trading Plan for the Week – There’s not much available this week. I exited my XLE long position on Friday with a 4.9% gain and now I’m sitting on the sideline in energy waiting for either a test of XOP 86 and XLE of 51 or a breakdown and retest of the lows around 77 and 46. I have no desire to take a position anywhere between those two points right now. My bias has turned from bullish back to a more neutral “wait and see” bias. I’m not yet bearish and definitely not interested in trying to short anything in the energy sector right now.
Outside of energy, I’m watching IWM 224-226 for a possible play. If there’s an area that could be a possible short, this is probably it. But it’s going to have to be an absolutely perfect setup with a concrete stop to manage the upside risk. My only market position right now is a long in IWM from 211. I probably should have sold that position on Friday at the same time I exited the XLE long, but I wanted to keep some exposure to the upside in the inflation trade and holding the IWM position seemed like the better approach. I’ll be exiting the IWM long on any failure of last week’s high, and then likely flipping short if the situation is right.
The only other area I’ll be trading this week are the banks, specifically XLF and KRE. The large cap financials are going to present a test around 37 which should provide some great information. If TLT breaks to the upside, it might be worth getting short XLF against 37. On the other hand, if TLT collapses, I’ll be looking at a long play in KRE off that 61.50 level.
One note about Friday’s exit on XLE, this wasn’t a great trading move and not normally something I do. The week away from the market was relaxing and it felt good to recharge, however it really took me out of the flow with the market. I left a really positive bullish situation and returned to something that was bearish, and that threw me off. I took the trade off to get my head right. The initial written trade was based on expecting a sharp move in XLE out of an extremely oversold area around 46-47 back to fair value around 51-52, however that move just didn’t happen like I wanted, which suggests the sector is weaker than I thought. If you are a longer term trader, you should use a wider stop than I did because there’s a good chance last week’s move was just a minor wiggle in the larger picture. I can always put this trade back on when/if XLE tests the 51 area or if it falls back toward 47. Sometimes regaining bigger picture rhythm is more important than short term profits.
This week is probably going to be one where I collect information rather than trade. It feels like most things I trade are in no man’s land right now and just not good risk/reward bets. Hopefully that changes this week, but patience is a must here. Now it’s time for a trip to the winery with the love of my life for a couple bottles and some live music. Good luck out there this week and don’t be in too big of a hurry to jump in this market.