Energy Sector Outlook

Failed breakout or false start?

Failed breakout or false start?

The S&P 500 Energy sector has been dealing with stiff resistance at the 2008 and 2014 highs for the better part of the last 2 years, and last month, we finally got that long-awaited breakout. Energy stocks hit their highest levels ever.

From big bases come big resolutions.. or maybe no resolution at all? Rather than capitalize on the momentum, Energy bulls haven’t been able to keep the rally going. Now we’re on the verge of a big, nasty failed breakout. If the Energy sector is below the spring 2022 highs (that’s at about 700 for the index and $92 for the XLE), we’ve got a problem.

If Energy does end up failing here, we know who to blame. It’ll be crude oil, which already put in a failed breakout of its own in mid-April. $85 has been the level to watch for WTI - we couldn’t not be bullish Energy as long as we were trading above it. But that’s no longer the case. We need to see a recovery sooner rather than later.

So why shouldn’t we be betting against Energy just yet?

In part, it’s because this is still a market where the value-oriented cyclical sectors are seeing the strongest breadth readings. 74% of S&P 500 Energy stocks are above a rising 200-day moving average, which is second only to the Financials at 77%. The Materials and Industrials sectors are next up, at 68% and 63%, respectively. That’s not a theme we want to be fighting - not until we see some real evidence of a reversal.

The other thing Energy bulls still have going for them is this chart of the sector relative to the rest of the market. Energy looked dead when it was breaking through a key area of relative support to start the year, but that breakdown was short-lived. We’re back above the 1999-2000 lows, and Energy is well-positioned to outperform going forward so long as that’s the case.

Digging Deeper - Our Favorite Energy Setups

The Refiners are still the best performers of the year, with the industry up 17% in 2024. They’ve given a lot back, though.

We set targets for a reason. It’s not because we can predict the future or because we know where a stock will peak. It’s because we need a way to assess the risk/reward of positions we take on.

Marathon Petroleum briefly surpassed our target of $200, but now it’s back below the 261.8% retracement from the 2018-2020 decline.

The same goes for Valero, whose breakout above our target of $175 turned into a failed move. After it hit our target, it was no longer our problem.

Both MPC and VLO are still in uptrends, and we’re still approaching them from a bullish perspective, but we can leave them both alone until the setups improve.

Leaders

If the Energy sector as a whole manages to stabilize above those prior highs instead of falling back below support, we want to be buying Energy stocks. But not just any Energy stock - we want the ones showing relative strength.

Like Diamondback Energy. Check out this beautiful 5 year base breakout for FANG vs. the rest of the sector.

On an absolute basis, FANG moved past the 161.8% retracement from the 2022 decline, and now that level should act as support here on the pullback. We like the risk/reward here, and we can own it above $195 with a target of $250.

More often than not, trends continue rather than reverse. That doesn’t mean trends never reverse. Look at Williams Cos relative to the rest of the sector. From the 2020 highs until this time last year, WMB was a textbook example of a downtrend - lower highs and lower lows, stuck below a falling 200-day moving average. Today, the opposite is true.

And WMB just broke out of a 2 year base. We want to be buying that breakout and want to continue owning it above $38 with a target of $44.

No stock has shown more relative strength than Targa Resources - it’s the sector’s top performer this year. There’s no trade here though, as it consolidates just below our $120 target.

Losers

Own relative strength, avoid relative weakness. The Energy sector was just at all time highs, APA Corporation just hit multi-year lows. Unless you’re bearishly inclined and approaching this one from the short side, there’s no reason to be involved.

That’s all for today. Until next time.