Why Energy Stocks Will Continue to Disappoint Investors

Energy stocks have underperformed, whilhe the tech sector's standout run has translated into big Nasdaq gains

by Joe Bell, CMT

Published on May 30, 2017 at 8:20 AM

We entered last week amid talk of impeachment and obstruction of justice -- but in this age of social media, news flows in and out of our consciousness faster than we can even begin to digest it. The week had politicians body-slamming reporters, discussions of whether Melania Trump would hold her husband's hand, and the deadly terrorist attack that shook England and the rest of the world. The stock market, acting as a reflection of human behavior, shrugged off this news and continued to show us just how strong an old-fashioned bull market can be.

As we have discussed in previous weekly commentaries, many of the broad-market indexes entered last week at or near potential overhead round-number resistance areas. Last week, I also highlighted that the positioning of fund managers left significant room for sideline money to flow back into U.S. equities, which could support these round-number levels being taken out at some point. Well, after struggling with these short-term peaks during the past few months, round numbers on the S&P 500 Index (SPX - 2,415.82) and Dow Jones Industrial Average (DJIA - 21,080.28) were indeed taken out during this past week. Let's take a good look at a few of the major U.S. indexes to get a clearer picture of what occurred.

On Thursday, the SPX moved above 2,400 and established a new all-time high. This follows the lows in the previous week near the 2,350 half-century mark (Todd Salamone has discussed numerous times the significance of SPX half-century levels as hesitation or pivot points). The 2,350 area was also the site of the index's rising 80-day moving average and a trendline connecting the late-March and mid-April low. As you can see in the chart below, utilizing the buying pressure from this area, the SPX finally surged above a level that has been a thorn in its side since the beginning of March.

spx daily price chart 0526
Chart courtesy of StockCharts.com


The Dow moved above 21,000, but is still just below its March 1 high -- which is also its all-time closing high of 21,115. The jury is still out on whether 21,000 is behind us for good, as moves to or just above this area have been quickly met by sellers in previous months.

djia daily price chart 0526
Chart courtesy of StockCharts.com


The Nasdaq Composite (COMP - 6,210.19) is in a slightly different situation than the SPX and DJIA. When analyzing an index or ETF, it is always important to understand what the actual holdings are, and not just think of it as a symbol. Approximately 45% of COMP components are technology stocks, whereas tech accounts for only about 23% of the SPX and 18% of the Dow, respectively. The COMP's heavier weighting in tech stocks has been handsomely rewarded in recent months, as you can clearly see in the chart below. COMP recently found support at the round-number 6,000 level in the previous week's sell-off, but took out its mid-month all-time high on Thursday -- confirming its leadership role in 2017.

comp daily price chart 0526
Chart courtesy of StockCharts.com


While technology stocks and the COMP maintain their leadership status, the same cannot be said for small-cap stocks. As evidenced by the chart below, the Russell 2000 Index (RUT - 1,382.24) is still well below the 1,400 level, as well as its all-time closing high from late April of 1,419.43. Its range since December 2016 continues, as it has continually bounced between the 1,350 area and just above the 1,400 level. It's also worth noting that the 2016 close of 1,357.13 is the site of much of the congestion that has occurred to start this year.

rut daily price chart 0526
Chart courtesy of StockCharts.com


Speaking of underperformance, let's talk about energy stocks. During the past six months, energy remains the one and only sector posting negative results. We continue to avoid this sector, as headlines that are seemingly bullish fail to produce meaningful buying. In addition to its underperformance, analysts' "buy" ratings on energy-related stocks have increased relative to a year ago, while short interest on these names has decreased only slightly. This is an unhealthy combination, and suggests energy could be a sector that continues to disappoint.

Many people entered last week with expectations that OPEC would extend its production cuts for another nine months, and rumors even surfaced that perhaps they would also increase the amount of the production cuts. This turned out to be a case of "buy the rumor, sell the news." Participants bid up oil in the days ahead of the OPEC meeting, and when the decision was announced (to extend cuts without increasing the magnitude), oil and energy stocks promptly sold off.

In addition, the Trump administration released its 2018 full-year budget proposal, which included the idea to sell $16.5 billion of oil from the Strategic Petroleum Reserve to help cut the deficit. In combination, it was not the best of weeks for energy stocks, as many were negative despite the SPX making a new high.

sector etf performance ytd 2017 0526


On the sentiment front, short interest on SPX components is starting to pick up after massive covering between March 2016 and the beginning of 2017. Total short interest on SPX stocks is up 8.4% since early February, when the index was trading around 2,270, or about 140 points below its current level. If the SPX was lower, I would view the advance in short interest as bearish, as the index weakens and shorts build positions. However, the SPX is higher -- so this could have bullish implications, as the shorts are in a losing position and thus more apt to cover, lending a supportive factor to the market.

spx stock short interest 0526


This week is a holiday-shortened one, but we will be faced with a few potentially market-moving events. April's personal income, personal spending, and PCE prices (inflation) will be released Monday. In addition, the ISM index will be released on Thursday, followed by the Labor Department's monthly payrolls report for May on Friday. All of this information may be relevant to investors' expectations for when and how often the Fed might raise rates this year.

As of right now, the CBOE FedWatch Tool indicates an 83.1% expectation of a rate hike at the June meeting, and is pricing in two more rate hikes before the end of the year. The minutes from the May 3 meeting were released last week, and the Fed gave a glimpse as to how it might begin to unwind its massive balance sheet later in the year. With the SPX comfortably above its May 3 closing level, and no rate hike earlier this month, we may be embarking on a repeat of the post-Fed rally from February.

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