Stock analysis

Energy Stocks May Have Bottomed Out

Crude oil and energy funds have perked up in the past two weeks, underpinned by supply disruptions caused by Hurricane Harvey and the possibility that Hurricane Irma will inflict equal or greater infrastructure damage. While the storms have triggered widespread suffering and financial loss, the timing could not be better for energy stocks, which posted a near continuous string of 2017 lows into recent weather events.

Mother Nature’s destructive catalysts have now lifted the most widely held energy fund above its 50-day exponential moving average (EMA) for the first time since early August, while volume indicators confirm the strongest bottom fishing so far this year. In turn, this bullish price action raises the odds that the group will continue to gain ground after short-term catalysts ease and the complex supply chain is back online. (See also: The Financial Effects of a Natural Disaster.)

The SPDR Energy Select Sector ETF (XLE) currently holds nearly $15 billion in assets, making it the largest sector fund traded on the national exchanges. It broke out above the 2008 high at $91.42 in 2014 and posted an all-time high at $101.52 a few months later. A downturn into 2015 accelerated into a full-scale rout, finally bottoming out in the first quarter of 2016 at the .786 Fibonacci retracement level of the 2009 into 2014 uptrend. (See also: What’s Behind Energy Earnings Growth?)

A recovery wave into December stalled at the 50% sell-off retracement, giving way to a channeled 2017 decline that is still in force nine months later. XLE fell to a 17-month low in mid-August and turned higher, setting off a short-term buying signal last week when it lifted back above the broken June and July lows at $63. The fund surged higher once again on Wednesday, closing above the 50-day EMA for the first time since Aug. 2.

On-balance volume (OBV) may have ended a climactic distribution phase last month when it fell to the lowest low so far this decade, with healthy buying interest since that time signaling the return of value players. However, the long-term technical tone will remain bearish until the price completes a round trip into the July high at $67.13 and ends the nine-month string of lower highs and lower lows. Not surprisingly, that level is now aligned with the 200-day EMA. (To learn more, see: Uncover Market Sentiment With On-Balance Volume.)

The SPDR S&P Oil and Gas Exploration and Production ETF (XOP) currently books the highest volume of all energy funds, reflecting its more speculative nature at a time when the sector may be bottoming out. It broke out at the same time as XLE in 2014 and also failed the breakout a few months later, descending in a multi-wave decline that tested the 2009 bear market low in January 2016. (For more, see: Performance Insight: Oil and Gas ETF.)

The subsequent bounce underperformed its rival, stalling at the .386 sell-off retracement level ahead of a channeled decline that cut through the .618 rally retracement level in August 2017. XOP remounted that level into September, setting off a 2B buying signal that denotes the failure of bears to defend a new resistance level, and it has now reached 50-day EMA resistance. A pullback now needs to hold the $29.50 to $30.00 support zone to keep the short-term recovery wave intact.

Limited buying interest in recent weeks signals hesitation by big money to take fresh exposure in the more speculative exploration stocks. It is normal for long-term recoveries to begin in the highly capitalized issues comprising the broader XLE fund, but the longevity of the nascent uptrend will depend on rotation into these smaller issues. As a result, observant market players will be watching XOP closely, looking for institutions to come off the sidelines. (See also: Oil and Gas ETF Industry Outlook.)

The Bottom Line

The largest energy fund has closed above intermediate support at the 50-day EMA for the first time in four weeks, signaling a recovery wave that could gain traction into the fourth quarter. As a result, it makes sense to keep close watch on price action once weather catalysts dissipate, looking for resilience that could support a longer-term bottom. (For additional reading, check out: These 3 Energy ETFs Are Starting to Look Bullish.)

<Disclosure: The author held no positions in the aforementioned securities at the time of publication.>