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Energy turning back lower relatively speaking after early year outperformance

July 25, 2016


2139-43, 2119-20, 2096, 2075-7    Support
2175-6, 2183-5                  Resistance


S&P remains in near-term consolidation mode following its steep run-up from late June.  The minor flag pattern thus far argues for a bit more strength into early next week before reversing.


Key Takeaways

US Equity Rally has given way to consolidation- Final upward thrust possible to SP-2185, but upside looks limited.   Still no evidence of near-term technical deterioration that would argue for a short directional bias, but the sideways range over the last seven trading days has caused some flattening in momentum from severe overbought levels and still suggests that upside gains from here should prove limited.    S&P's gains from mid-June have consolidated now for nearly two weeks after the initial steep run-up, which has helped to alleviate some of the severe overbought conditions, while not really showing much evidence of any pullback.  This move back to new all-time high territory for S&P, and DJIA has still not been followed by the NDX, nor the Small and Mid-cap indices, as gauged by SML, MID still resting near prior all-time highs.  NDX remains near prior highs from last year, while other laggard indices like the DJ Transportation Avg, or Russell 2000 index remain far off these highs to the tune of 10-15%.    At present, S&P remains nearly 2 standard deviations above its 50-day moving average, while more than 86% of SPX stocks are trading above that same 50-day moving average. Traditional momentum gauges such as RSI have neared overbought territory on daily charts, while weekly and monthly charts are showing RSI readings in the high 60's.

Bond yields and USD/JPY, which BOTH rallied along with Stocks, now stalling out.  Important to watch-    Bond yields and USDJPY both rallied during the same last few weeks as Equities, and both have shown evidence of stalling out in the near-term at areas of key trendline resistance.  Given that bond yields turned down sharply in a manner that led to equities following suit, and then rallied in the last couple weeks while Equities also bounced, it's noteworthy that bond yields both in US and in Germany look to be near key resistance.   Given the historical positive correlations between both TNX, USDJPY and SPX, a pullback in the next week could coincide with equities weakening as well.  For now, patterns in most Equity indices show evidence of slowing down at or near prior highs (NDX, CCMP, SML, MID, while Equity ETFs like XLI, XLY, XLE, XLB all encountered resistance near prior peaks of some sort. )  While this doesn't necessitate a strong reversal to give back all of the recent gains, it does suggest consolidation and/or a good possibility of a minor reversal in the week ahead, which would create a noticeable headwind for Equities.  In addition, pullbacks in TNX would be detrimental for the Financial space, which could give back some of its recent gains, both in the US and in Europe.

Sentiment has quickly turned from bearish to bullish in the last month.  Gauges like DSI (Daily sentiment index) now show readings in the high 80's, CNN's Fear and Greed index also show the high 80s' (Extreme Greed) while Investors Intelligence and AAII polls have continued to widen out in their percentages of Bulls vs Bears.  Finally , Equity put/call readings dropped down from over 1 back in late June to under 0.60 last week, while the 10-day moving average of the Equity put/call remains under 0.60 which represents the lowest readings since last Spring, directly proceeding the market peak. VIX readings at 12 are an additional concern, given that not too much has happened to erase the uncertainty that was present a month ago, outside of a small improvement in Economic data.  (Certainly very little changed in most Macro data, and not enough to suggest a 50% drop in implied volatility in the thick of earnings season.)  VIX futures data shows a fairly steep curve right now between front month and 3-6 month VIX futures, and often pinpoints times when Spot Implied volatility is too low.

Sector-wise, the improvements in Technology, Healthcare and Consumer Discretionary last week were certainly constructive, while Energy continued to lag all other nine S&P sectors given the drop in WTI Crude oil.   Just in the last couple days, a few meaningful developments in that Utilities and Telecom began to show strength, despite any significant pullback in either Equities or Treasury yields, while Transportation index declines in Airlines weighed down Industrials, and Energy showed further signs of breaking down.   With regards to Utilities, this group looks ripe to bounce in the weeks ahead technically speaking when viewing this sector relative to the SPX

This week's report will concentrate on the recent woes in Energy, a group which has lagged all other nine sectors over the past month, and which showed evidence of weakening further last Friday given the breakdown in Crude oil under $45, while OIH violated key trendline support vs the SPX in relative terms.  Given that the US Dollar's gains look likely to continue in the short run technically, (which has already begun to adversely affect commodities) further near-term weakness looks possible for Energy as WTI Crude continues its recent pullback, and underweighting the Oil Services and Exploration and Production stocks looks right in the short run.

Within Energy, there are a few points to remember technically speaking.  First, despite there having been minimal damage to the trend from January lows in the rally in either XLE, or OIH, the intermediate-term trend from 2014 highs remains very much broken with the rally in the last six months barely having made a dent in the decline over the last couple years.  In the case of OIH, our six month bounce recouped less than 30% of the prior decline.  Additionally, the breakdown which occurred was relative in nature vs the SPX, which occurred last week on a violation of key trendline support vs SPX.  Often these can lead to declines on an absolute basis of the trend, and are worth monitoring.  In the case of Energy, it's been the third best sector on a YTD basis, with 14.36% gains, while the worst performing sector over the last month, returning a paltry 1.06% (S&P 500 Energy index) vs S&P gains of nearly 4.5%.  Even on a three month basis, this has lagged all other sectors except Financials.  This goes a long way towards showing how the majority of this year's outperformance really happened between late January and May.

Oil Service stocks look to have begun to deteriorate on a much quicker basis than Integrated and E&P names, which might be expected.  However, Equipment and Service names still are showing much better strength than the Refiners, and that looks to last another 2-3 months before this reverses time-wise.  The Refiners have underperformed nearly all other parts of energy this year, and thus far, while now getting stretched to the downside, don't yet appear to be at lows.  Shorting these names looks like a poor risk/reward, but buying also looks a bit premature.  With regards to E&Ps, Exploration and Production stocks have shown signs of weakening vs the broader energy space right near when Crude turned down in June.  For now, these also should underperform within Energy as this underperformance continues.  The Drilling group also looks quite weak and never made sufficient progress as a sub-sector to warrant favoring these stocks for anything more than a bounce. 

Comparing Energy to other sectors, technicals show that most of the sectors are preferred over Energy, with Healthcare and Technology turning up sharply in recent weeks, and even Utilities looks like a better bet.  Overall, while this sector had experienced a nice bounce into the Spring, it's important to be more selective than ever within Energy, and while it ranks third out of all sectors for 2016 performance, Energy still looks very much like a laggard vs many of the other top sectors, and has just turned down vs the broader market as a whole in the last couple weeks.

Short-term Thoughts (3-5 days) :  Neutral- While upside might prove limited with nearly 90% of issues now above their 50-day ma, the pattern on a short-term basis still isn't all that negative, and resembles a flag formation on E-mini S&P charts which could give way to one final push up to 2180-5.  However, the neutral ranking for the next week concerns many of the other indices, such as the S&P Mid-cap and Small-cap index, both of which are pinned near former highs, while NDX is also right up near prior highs now.  It's doubtful that indices breakout en-masse and show a huge upside acceleration given sentiment levels combined with near-term overbought conditions. Extreme selectivity looks to be required over the next few weeks, using rallies to take profits and concentrate on stocks with attractive technical patterns while utilizing tight stops.

Intermediate-term Thoughts (2-3 months): Bullish- Last Week's breakout to new high territory for SPX likely should soon be followed by other indices such as DJIA while NDX, CCMP should push up to test former all-time highs from last year.   While the ongoing lagging in Transports and Small caps is a concern, as these remain 10-15% from all-time highs and similarly, most of the world remains well off all-time highs, it's right to stick with US stocks until some evidence of counter-trend sells arise or breadth starts to falter meaningfully in a way that would lead to a top in stocks.  Both daily and weekly momentum as per MACD are positively sloped, while monthly is sloping upward and close to turning back positive for the first time since early 2015.  Bottom line, with Advance/Decline at new highs, it's difficult to fade the market, and the lagging sectors have all started to bounce in a way that should lead to some mean reversion in these sectors.  Key cycle dates for trend change lie in late August, and very well could lead to a peak in stocks, but for now, it's right to stick with this trend on an intermediate-term basis until ample signs of weakness arise.  The other concern is that given the degree of deterioration in momentum last year into those August lows, even this push to new highs won't allow momentum to get anywhere near where it was back in late 2014/early 2015 and this is a 12-18 month concern.  For now, for this time frame, additional intermediate-term strength still looks probable with key targets at 2180-5 and then 2250.


Energy-  Sector Charts on Absolute/relative Basis, along with 3 Stocks to avoid/short.    The early year outperformance in Energy looks to have run its course-  Extreme selectivity needed for the months ahead.




WTI Crude- Bearish down to 42.75 near-term-  Last week's pullback slipped back under early June as well as May lows, violating the 38.2% retracement that had held Crude intact over the last month, not to mention its 200-day moving average.   While it was possible to make the case that Crude really hadn't shown too much technical damage from its January lows, last week changed that with the decline back under $45.  Given the bearish inventory data and the near-term downward acceleration in price, it's likely that WTI experiences a bit more downside to the 50% retracement of its January-June rally, or near 42.75.

Energy relative to the SPX, as seen by ratio charts of OIH to SPX, has just broken down under the entire uptrend line since January as of the last week.  Energy had already been the weakest sector over the last month, and this violation of the uptrend likely could cause this underperformance to grow larger in the next few weeks.   Just as WTI Crude should have some good support down near $42.75, or around $1 lower, Energy looks to show further near-term underperformance between now and mid-August.  So for now, this sector should be avoided and extreme selectivity is needed when buying into Energy.  


Oil Services index (OIH- $28.58)  While the relative trend has broken down, the actual OIH trend in absolute terms remains intact at this time, but should be watched carefully for signs of trend violation.   Violations of $28 should lead to a test of June lows at $27.15, with little under that level until $25.50.  Breaks of June lows would be a larger signal that a much deeper retracement could happen to this rally from January.  On the ability of OIH to get back over $30.15, made on 7/12, that would go along ways towards thinking pullbacks should be postponed.  For now, the relative price action is a distinct warning to a breakdown of OIH on an absolute basis.


XLE/OIH-  XLE favored over OIH-  While some Integrated stocks like XOM have shown very good outperformance already in the last few months, its the deterioration in Drillers and other service stocks that have caused this ratio to turn up more sharply in recent weeks.  After last week's breakout to new multi-week highs in XLE to OIH, it's likely that this ratio continues showing good near-term strength, which favors XLE vs OIH, the latter which broke down in bigger fashion vs the broader market given last week's decline in ESV, RDC, DO, NBL, RIG, and HP all of which declined more than 5% on the week.



Equipment & Service Stocks Relative to Refiners-     Equipment and Services continues to look attractive vs the Refiners, which have lagged all year and continue to show huge underperformance vs the rest of Energy.  Two of the top refining stocks, TSO and VLO, are this year's worst performing issues within the XLE, down 29.46% and 28.04% respectively in data through 7/22/16.  While Refiners have now gotten stretched to the downside, it's premature to try to buy dips in these, and for now, this ratio of Equipment and Services remains upward sloping.  A trend violation in the relative chart of Equipment & Services vs Refiners would argue to exit OIH in favor of stocks like TSO and VLO for energy exposure, which for now, still looks premature.


The Exploration and Production stocks made a sharp bounce vs all of Energy into around May of this year, before turning down in the last month.  As this chart shows, this bounce barely recouped any of the prior decline and still looks like it needs to pullback in the weeks ahead after just brief progress.  The weekly chart of E&Ps vs all of Energy remains in poor technical shape, with the bounce barely recouping 40% of the prior decline.  The rollover over the last couple weeks has helped to turn the intermediate-term trend back to negative, and should result in another 3-4 weeks of underperformance out of this sub-sector before any kind of stabilization.  The XOP ETF therefore likely should be underweighted vs all of Energy until this relative chart begins to show better signs of strength and true bottoming out.


Healthcare vs Energyhas made encouraging progress in relative terms as might be expected with Crude turning lower and Energy lagging all other sectors in the last month.  The relative chart of XLV vs XLE shows a stellar technical rounding bottom pattern in place since early this year, suggesting that Healthcare should continue to be a better relative area to show outperformance vs Energy.  This ratio has just hit the highest levels since early April, but this bottoming formation is likely to result in better outperformance in the months ahead for Healthcare vs Energy.


National Oilwell Varco (NOV- $32.25) The multiple stabs higher in NOV which have failed over the last few months are telling as to the ongoing weak structure of this stock.  Each of the rally attempts since February resulted in only minor gains before a deep retracement, which has been far more damaging than constructive when thinking this stock could be bottoming.  Movement back down under this mild uptrend is likely in the months ahead, which would get a jumpstart after testing and breaching June lows, just north of $30.  Overall, NOV has been a chronic underperformer since Energy bottomed in January and remains one of the worst performing stocks with YTD performance of -3.70%, putting this in the bottom tier of performance.  Overall, given the breakdown in WTI of late, it's likely this should continue to lag, and likely breakdown to support near $28.50 in the months ahead before any serious attempt at bottoming.



Diamond Offshore Drilling Inc (DO- $23.52) DO has begun to drop off noticeably over the last month, one of the worst performing stocks in all of Energy with a -7.84% in the rolling 30-day period through 7/22/16.  The break of the uptrend from January gave way to some sideways trading over the last few months before last week's breakdown to the lowest levels since Spring.  Technically speaking, DO peaked out right at the edge of its Weekly Ichimoku Cloud in the last month, a strong area of upside resistance.  While the stock has already given up $3 since mid-July, or over 10% in the last couple weeks, the pattern suggests that DO is rolling over after its near 80% rally from January lows.  Any bounce attempt in the next 1-2 weeks should be an opportunity to take profits on longs, or consider shorts for aggressive traders for a technical move down to near $20.25 in the months ahead.  For now, this recent momentum downturn along with structural weakness look to be key reasons to avoid this stock technically, despite the extent of the recent weakness.


Murphy Oil Corp. (MUR- $29.02) MUR has begun to show increasing signs of underperformance which began nearly three months ago and has continued in recent weeks.  It ranks the third worst performer of any of the Energy names through 7/22 on a one-month basis with -8.08% returns, and is likely to retrace at least half of its rally from January lows, which would target $25.89.  Some might view this pattern as being more of a consolidation type structure from April peaks, but last week's decline should allow for at least a test of the bottom of this range, which would allow for a pullback down to $27.31.  Weekly charts show MUR stalling right near the declining Ichimoku Cloud which was also present as a source of resistance for DO, above.  For now, this remains a huge near-term laggard, and Crude's breakdown is not likely to suggest any stabilization in the short run.  Additional underperformance looks likely, and this should be avoided until/unless it can manage to reclaim $33.35, which looks unlikely for now.




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