February Energy Outlook – Unlocked

We downgraded the Energy sector shortly after publishing our December outlook. Bearish weekly momentum divergences on both the relative and absolute charts had us cautious about the future of the sector.

Nothing has changed. Except perhaps that we’re even more concerned about the future of the sector.

Remember, momentum divergences don’t always lead to trend reversals, so we’re ready to reinstate Energy’s overweight rating should prices resolve higher. For now, though, we see weakness as a more likely outcome.

The sector is dealing with resistance from the 2014 highs. For those of you that have been around that long, 2014 was the year that oil prices began a huge, multi-year decline. That former peak has some memory.

Here’s a chart that screams trouble. The Integrated Oil & Gas industry just put in a failed breakout above its November highs. What’s more, momentum failed to even get overbought on that rally. You’re probably tired of reading the same words over and over again, but we’ll say it again. From failed moves come fast moves in the opposite direction.

Crude oil breaking below 70 could be the trigger that sends the Energy sector into a tailspin.

One bright spot has been Hess, which recently broke out above its 2008 highs. We can still target 200 if the stock is above 140, but if it’s below those ’08 highs, we want to take note for potential weakness in the rest of the sector.

Are Energy Stocks Close to a Bottom?

Last week I talked about the changing oil supply dynamics. This week, I decided to follow up with a look at stocks in the Energy space.

Simply put, Energy stocks have not been a good place to invest over the past 10 years. Below is a ratio chart of the sector to the S&P 500. After a stellar run of outperformance from 2000 through early 2008, Energy has been in a clear downtrend relative to the overall equity market. The collapse in oil prices that began in 2014 only exacerbated the underperformance. (Click chart to enlarge)Energy vs SPX

Has Energy really been that bad, or is the above chart merely the product of a more than 300% rally by the S&P 500 since its 2009 lows? It’s more of the latter. The sector climbed off its 2009 lows, too, but failed to hold a break to new highs in 2014. Now it sits near the midpoint of a range it set up more than 10 years ago. Though prone to rapid rallies and steep declines, Energy stocks have gone nowhere for a decade.Energy.PNG

Crude oil, though, has begun to show signs of progress. While still well below 2008 highs (and far from being in a convincing uptrend), oil prices have set a series of higher lows and have spent much of the last 18 months above their 200-week moving average. Is it time for Energy to make another run at its highs? It’s possible.

Two sub-industries – Integrated Oil & Gas and Exploration & Production – make up nearly 75% of the overall sector. Both groups set new highs and subsequently failed to hold them in 2014, and both lack much of a trend.Integrateds.PNGExploration and Production.PNG

While these two don’t offer much in terms of nearby levels to watch, the other 4 sub-industries are near important areas. Their action could be a clue as to how the larger, more important industries resolve their years-long consolidations.

The Oil & Gas Storage & Transportation Sub Industry is currently testing the $200 level for the 7th time in the past 3 years. Some technicians argue that the more times a level is tested, the more likely it is to break. Others say it only reinforces it. Either way, the area clearly has importance and a break above it would be a positive for Energy stocks.Storage and Transportation.PNG

The Drillers have underperformed the rest of the sector and are currently below even their 2009 lows. The trend is still down – the price is below a downward-sloping 200-week moving average – but the industry has managed to hold above $120 for 3 years now. Consolidation patterns like this wedge (marked by the red trendlines) should be expected to resolve in the direction of the existing trend, so a break higher would be a notable win for Energy bulls.Drillers.PNG

The Q4 2018 decline in the Equipment & Services group broke what had been an important support level at $400. That level will be tough resistance going forward. Even a 50% rally from current levels would leave prices below their currently downward-sloping moving average, but a recent failed breakdown below the December lows and a bullish momentum divergence suggest that a meaningful bounce could be coming.

Equipment and Services.PNG

Refiners were setting new all-time highs as recently as last year. A decline over the last 8 months has them back-testing the 2007 highs near $700. A weekly close below support on May 31 was worrisome, but prices have since rallied 15%. As long as they’re above $700, the Refiners are structurally healthy.Refiners.PNG

Energy hasn’t been a fun place to be for a long time. Relative to the rest of U.S. equities, they’re still in a downtrend, and the biggest industries in the sector are stuck in massive consolidations. But the smaller groups are testing key levels that could give us clues as to how those massive consolidations will resolve. Maybe upside resolutions across the board will be enough for this sector to start outperforming again. Stay tuned.

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Nothing in this post or on this site is intended as a recommendation or an offer to buy or sell securities. Posts are meant for informational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in posts. Please see my Disclosure page for more information.