Oil and Energy Diverging

It seems like the energy sector debacle has received very little attention among the mainstream media this year. Even the financial media don’t really care. I am guessing that’s because crude oil has somewhat bucked the bearish trend the stocks have been on as you can see below. Oil has been very volatile and mildly lower. The stocks have been downright ugly. This has been an unusually long period of behavior like this.

In the past, the stocks have usually been on the correct side, but the relationship currently seems to be broken. Of course, people are going to speculate nonsense about OPEC and shale and manipulation. Don’t buy it! If I had to put a trade on right now, it would be to own the energy stocks and short crude oil. If I had to choose, I would look for a final bout of capitulation where investors throw in the towel all at once and then look to buy energy stocks. That’s what has been missing all along.

Investors just keep holding on to the likes of Exxon and Chevron and the like, hoping they will bottom. That’s the kind of behavior we saw during the Dotcom Bubble bursting 17 years ago although I do not believe energy is even remotely like that.

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Energy Collapse. An Opportunity?

Stocks continue to bounce after the tensions with North Korea have quieted for now. As I have written about before, I think the stock market used North Korea as its catalyst or excuse to pullback. The underpinnings were a little weak and a little decline was coming regardless. My thoughts remain the same that the pullback is not over and the major indices will need to step it up sooner than later to revisit the old highs.

Every now and then I have mentioned the energy sector this year as it has been under what seems to be constant pressure all year. A few times, I saw short-term opportunities that never transformed into anything more. With this latest bout of selling the sector is once again approaching a window of opportunity. I say “approaching” as the opportunity is not here. I think we need to see the baby thrown out with the bathwater so to speak. It would be great for that to coincide with a piece of particularly bad news for the sector. You know. The things that bottoms are made of.

For now, let’s just watch the XLE ETF day to day and see if the opportunity sets up in a way where risk can be defined. It’s unlikely that it will quietly find a low with this kind of carnage.

Tomorrow, we will look at how crude oil is trading vis a vis the the energy stocks.

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Bulls Remain Large and in Charge Despite Pullback

We had a lot of negative news between Friday’s market close and Monday’s open, almost all on the geopolitical front with the vast majority surrounding President Trump. Of course, Deutsche Bank finally agreeing with the markets that they needed to raise capital was icing on the cake. In a weak market, that backdrop would have yielded a 1-2% lower opening on Monday. In a strong market, we’re talking about .25-.50% lower.

Stocks are due and have been due for a pullback or at least a pause to refresh. That looks like what’s happening right now. With so many investors on the outside looking in, any weakness should be mild and followed by further strength until more serious cracks in the pavement develop. I found it interesting that CNBC’s Fast Money midday report was all about the Trump rally ending. I think those pundits will regret those words.

As I watch the major indices and sectors come off their morning lows, I can’t help but notice that high yield bonds are not following suit and lagging. One day or a few days means absolutely nothing, however, should stocks rally with junk bonds falling, I would become more concerned.

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Volatility Genie Trying to Pop Out

After what has been celebrated as this huge, epic rally on Wednesday, the major stock market indices gave back all of their post 9:30am gains and then some on Thursday. I mentioned the other day that volatility compression leads to volatility expansion and vice versa. When the volatility Genie finally gets out of the bottle, we will probably see a sustained increase. I think we’re close to that now. Please remember, volatility does not always mean decline. It means wider price movement in both directions.

Right now, the important takeaways from the week are that small and mid caps look the most vulnerable, relatively speaking. All of the indices remain overbought and stretched but I do not see a large scale decline unfolding. Emerging markets and commodities are under pressure with gold clearly failing at its 200 day moving average. I wrote about oil peaking the other day and the decline may be starting. High yield bonds and the NYSE Advance/Decline Line continue to act well which should buffer the downside. Three out of four key sectors scored fresh highs this with semis very close although banks saw a nasty reversal from new highs on Thursday.

Altogether, this behavior remains very typical of bull markets. Weakness should be bought.

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Energy Stocks Forecasting Crude Oil Decline

Good morning! As I finish this up, I am back at the airport waiting to board an earlier flight than expected back home. I was hoping to sneak away for a few hours and race through 18 holes, but Mother Nature gave us so much rain that the golf course and driving range were closed. So rather than waste a full day, I booked an earlier flight on the always flexible Southwest Airlines. At the same time, my 8 year old called me and said, “Dad, will you please come home right away.” That made the decision a layup and I will surprise them when they get home from school.

The stock market ended the month with lots of yawns. It has been a downright boring week or so. Long time readers know that volatility compression leads to volatility expansion and vice versa. The longer it stays quiet, the bigger the move, perhaps in both directions, when the boredom ends. Very quietly, the defensive sectors have been showing the strongest price action. Utilities, staples and REITs are all at fresh 2017 highs with very little fanfare. If my four key sectors weren’t behaving so well, I would be much more concerned.

One area which has been somewhat of a head scratcher for me is energy. With crude oil trading well and close to new highs, as you can see below, you would think that the energy stocks should be somewhat strong and following suit.

However, that’s just not the case. The next chart below is the exchange traded fund, XLE, or the grand daddy of energy ETFs. After peaking in mid-December, it’s now down roughly 10% with Exxon Mobil at new lows and down almost 15%.

The oil service sub-sector is below and it, too, acts very poorly against the solid crude backdrop. Something just ain’t right.

With the stock market behaving very well and crude oil close to new highs, the energy stocks should be a market leader. They are not even a mid-level performer. Historically, the stocks are smarter than the commodity and lead. Couple that with extreme levels of smart money selling crude oil and you have the makings for a peak in oil and significant decline on the way.

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Santa Claus Rally Just Around Corner

Big picture. Late October through mid January is the strongest seasonal period to invest in stocks. That’s fact.

Over a similar but slightly different period, the semiconductors are the strongest group to invest in. Just since the October bottom, they are up 27% and I am very glad we own them in our sector program. They made up for some crummy positions we have held during the same time.

Early December shows some slightly negative seasonal headwinds, like we are seeing now. In bull markets, these headwinds usually turn to tailwinds over the coming week.

The much maligned and beaten down Russell 2000 index of small cap stocks has its most favorable period right now through early January, one of the “January Effects”. Tuesday’s wide daily range in the Russell turned the index from breakdown mode to possible breakout mode next week or the week after.

The traditional year-end or Santa Claus rally often seen in bull markets is set up to begin shortly and take the Dow above my longstanding target of 18,000 with the likelihood that small and micro cap stocks finally show some outperformance in an otherwise crummy year for them. I would be concerned and question that scenario if the Russell 2000 closed below Tuesday’s low, roughly 2.5% lower from here.

There are always many crosscurrents in December and this year is no different with most of the market doing well, while the energy sector is under severe pressure. Tax loss selling in energy stocks is supposed to wrap shortly and that group should see at least a reflex rally, regardless of where it is going next year. At the same time, with so many portfolio managers trailing their benchmarks, it’s very difficult for the bears to make any headway until next year. Any 1-3% decline should be quickly gobbled up, especially in the sectors and stocks that have performed the best in 2014.

Like I said, lots of crosscurrents through year-end…

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