Divergence convergence

08/20/19
  • Oil stocks failed to rebound with crude—until yesterday
  • Energy sector has also lagged broad market
  • CVX one of the stronger oil stocks in recent weeks

It has not been the best of times for oil-stock bulls, and that’s been true whether you’re talking about the past year or the past 10 days.

Oil stocks can be a bit of a feast-or-famine area of the market, since two major drivers sometimes work together to exaggerate their moves, to the upside or downside. First, there’s the price of crude oil, which can pump up energy stocks even when the broader equity market isn’t in a raging uptrend, and weigh them down when it is. But when the two are in sync, it can be good times for oil bulls.

Unfortunately, US crude is still more than $20/barrel below its levels from October 2018.

In the absence of an exceptional crude oil trend, though, energy stocks will generally follow the twists and turns of the broad market, as shown in the following chart of the SPX and October WTI crude oil futures (CLV9):

October crude oil (CLV9) and S&P 500 (SPX), 12/31/18–8/19/19. Equity–oil linkage

Source: Power E*TRADE


But crude oil’s role as a proxy for global economic health also comes into play, in a nutshell: economic outlook good, oil demand good; economic outlook bad, oil demand bad.

The past two weeks of market action were particularly interesting in this light, since, as the following chart shows, while crude oil (red line) rebounded off its August 7 low—testing but not breaking its early-June support level—many energy stocks, including Exxon Mobil (XOM) and ConocoPhillips (COP), broke down to new lows:

October crude oil (CLV9), Chevron (CVX), Exxon Mobil (XOM), ConocoPhillips (COP), 12/20/18–8/19/19. Some oil stocks overshot crude sell-off

Source: Power E*TRADE


Take another look at the first chart and you’ll see that the SPX held its June lows, too, which means we’re seeing weakness in oil stocks when both crude oil and the broad market are rebounding, or at least holding their ground.

No wonder stories about “oversold” energy stocks have been popping up lately.1

The rub is, you can find similar stories from November of last year after the market pulled back in October2—six weeks before it (painfully) bottomed in late December. “Oversold” is an adjective, not a contractual obligation to rally.

So, while something that’s oversold can clearly get even more oversold, it’s also true that if oil was oversold in November when it was trading around $65, it’s more oversold now when it’s trading closer to $55. (Of course, this assumes that the global economic outlook is relatively unchanged since then.)

That said, when trading it’s a good idea to drill down to a particular stock’s condition rather than rely on general assessments of a sector’s level of oversold-ness. For instance the following chart shows Chevron (CVX)—the stock exhibiting the greatest strength in the previous chart—retreated close to -9% from its July 25 high of $127 (stopping just a couple bucks shy of its June 3 low of $113.72) before rebounding yesterday. Oil was up, too, and energy stocks topped the SPX sector listings.

Chevron (CVX), 6/3/19–8/19/19. Chevron price chart. Nearby support, nearby resistance.

Source: Power E*TRADE


The bounce pushed CVX shares into a zone containing the early-August lows. Many traders will likely consider this area a short-term resistance level that the stock will need to push above for the rebound to have a chance of developing legs. If it instead quickly fizzles in this area, those traders may then look for the stock to test support, the most likely target being that June low.

If history is any guide, there’s going to be plenty of action in oil and oil stocks in the near future. But leave the “oversold sector” observations to investors, because in the near-term that action is likely to be on both sides of the market.

For traders who focus on specific trades with well-defined risk, that can mean more opportunities.

Today’s earnings include: Toll Brothers Inc (TOL), Kohls Corp (KSS), TJX Companies Inc (TJX), Home Depot (HD), Urban Outfitters (URBN), Medtronic PLC (MDT).

 

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1 Barron’s. Wall Street Has Abandoned Oil and Gas Stocks. You Shouldn’t. 8/16/19.

2 CNBC.com. Oil is oversold at this stage, says expert. 11/8/18.

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