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U.S. energy stocks are poised for a potential relief rally

By Kelvin Wong

U.S. energy stocks are poised for a potential relief rally

2015 Performance of U.S. Sectors 


(Source: StockCharts.com)

It is very easy to see which sector is the worst performer for 2015 in the U.S. stock market. It is the Energy sector which finished last year with a horrendous decline of 21.86%!  Simple answer as the main catalyst for causing this dismal performance in energy stocks is the plunge seen in oil (see attached chart of the light sweet crude oil (WTI) futures with the Energy sector ETF (XLE), their movements are in a lock step fashion!).

Thus, we can conclude that the movement of the XLE is highly direct correlated with the movement of oil. The plunge of WTI from its June 2014 high of 107.73 is caused by a supply glut as OPEC ramped up production to compete in market share with U.S. shale oil producers and sluggish global demand.

Going forward how will the U.S. energy sector perform? Let’s us decipher it from a technical analysis perspective.

Light Sweet Crude Oil (WTI) futures

Since the fortunes of the U.S. energy related equites are dependent on the movement of the light sweet crude oil (WTI), we will start the ball rolling by examine the charts of WTI futures.

The on-going steep decline of 75% from 107.73 high of June 2014 to a current low of 26.05 seen last month, February 2016 is almost the same in magnitude seen in the previous two oil crushes in July 2008 to January 2009; 77% and Oct 1990 to November 1998; 73%.

Given such statistical measures, the likelihood of a further slide seems to be lower in probability at this juncture as compared to a pull-back/consolidation scenario. Zooming into the weekly chart, the downside momentum of the decline from June 2015 high has started to wane as the weekly RSI oscillator; a measure of price momentum has shaped a bullish divergence signal at the oversold region.

A break above the key 36.50 intermediate resistance (the major swing low area of January 2009 and the upper boundary of the descending channel in place since June 2015) is likely to trigger a potential multi-month pull-back/consolidation (countertrend rally) scenario towards the next resistance at 50.80 (the swing high of 05 October 2015 and the pull-back resistance of the former trendline support from November 1998 low).

Positioning of major U.S. Energy stocks

Description: Z:\Equities\2016\XOM short interest against float.png

Description: Z:\Equities\2016\CVX short interest against float.png

Description: Z:\Equities\2016\SLB short interest against float.png

(Source: gurufocus.com)

The top three holdings of the SPDR Energy Select Sector ETF (XLE) are Exxon Mobil Corp (XOM), Chevron Corp (CVX) and Schlumberger Ltd (SLB) which make up a total weight of 42.35% in the XLE ETF (source over here)

Therefore, it will be interesting to see investors’ sentiment on these heavy weightage energy stocks as their movement will have a greater impact on the XLE. In order to have a gauge of investors’ sentiment we will be looking at their positioning (actual trades) on these stocks and we use the short interest percentage of the float where short interest is the number of shares sold short in view of a further decline in the near future and float is the portion of shares of a company that are in the hands of public investors as opposed to “lock-in” stocks held by company officers, controlling-interest investors or government.

As at 12 February 2016, the short interest as a percentage of the float for XOM, CVX and SLN are elevated on the upside and on the average these figures are at a three year high which translates to an extreme bearish sentiment positioning by investors.

From a contrary opinion perspective, these stocks are subject to the risk of a short squeeze where short sellers cover their short positions if there is sudden knee jerk price action on the upside. These actions caused by “shorts covering” will tend to see a steep follow through in price action on the upside given such “overcrowded” bearish positioning on these stocks at this juncture.

SPDR Energy Select Sector ETF (XLE)

Interestingly, the similar steep decline seen SPDR Energy Select Sector ETF (XLE) has managed to stall a major support zone of 56.20/49.90 (the long-term trendline support from July 2002 low, swing low areas of 28 June 2010/03 October 2011 and a Fibonacci cluster). In addition, the weekly RSI oscillator has shown a bullish divergence signal at its oversold region which suggests a slow-down in the downside momentum of the on-going major downtrend in place since June 2014 high of 101.52.

As seen from the daily chart of XLE and from an Elliot Wave Principle perspective, we can see a clear five waves  structure on the downside from its June 2014 high of 101.52 (labelled as 1/,2/,3/,4/ & 5/) to the 49.90 support. From an intermediate degree (multi-weeks to months), the current downtrend of XLE is now due for a potential corrective pull-back on the upside in a three waves (a/,b/,c/) sequence at the minimum.

Key levels (1 to 3 months) of SPDR Energy Select Sector ETF (XLE)

Intermediate support: 55.07

Pivot (key support): 49.90

Resistances: 62.15 & 71.70

Next support: 38.60

Conclusion

Putting everything together from intermarket analysis and positioning studies, the XLE is due for a corrective “relief rally” after a steep downtrend in place since June 2014. As long as the 49.90 long-term pivotal support holds and a break above the 62.15 intermediate resistance (upper boundary of the descending channel from June 2014 high) is likely to trigger a potential “squeeze up” to target the next resistance at 71.70

On the flipside, failure to hold above the 49.90 pivotal support is likely to see the continuation of the “death spiral” towards the next support at 38.60.

Source:  XLE and WTI futures charts are from eSignal

Disclaimer

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kelvin_wong
Kelvin Wong, CFTe

Chief Technical Strategist (Asia), City Index

Kelvin is professional technical analyst with extensive experience in stock indices, equities and foreign exchange. Kelvin employs a combination of fundamental and technical analysis and specialises in utilising Elliot Wave and Fibonacci analysis to pin point potential reversal levels in the financial market. Prior to joining City Index, Kelvin has traded actively and provided investment advisory for institutional traders/investors such as Deutsche Bank, Credit Suisse, ANZ and Goldman Sachs. He has also conducted technical analysis related trading workshops and seminars for thousands of private traders in Singapore and Malaysia.