Crude Oil Leads Stocks Lower

In early October, I examined the technical outlook for crude oil and the energy stocks. At the time, energy stocks, as represented by the Energy Select Sector (XLE), had dropped 14.6% in September and was down 45.5% for the year.

This was a very weak performance compared to the overall stock market, like the S&P 500, which is up 2.6% YTD. Fundamental analysts looking at the supply and demand for crude oil have expected prices to be stable going into the end of the year, while others looked at energy stocks as a value play due to measures such as their price-to-book value. However, as a technical analyst, my question is, how has the technical outlook changed as we near the end of the month?

Crude oil continued to underperform the overall market, and led stocks lower for most of the week. Many take the view that crude oil and stocks always move together, but the relationship is often much less clear than that.

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This long-term chart goes back to 1993. As you can see, while there are several times when the S&P 500 is rallying or declining with crude oil, there are a number of exceptions. For example, from 1997-1999 (line 1), crude oil dropped but stocks moved higher. Stocks topped a few months ahead of crude oil in 2000, and crude bottomed ahead of the stock market in 2002.

The stock market and S&P 500 topped in October 2007, but crude oil did not top until June 2008 (line 2). Both markets bottomed in early 2009, after which both markets rose until June 2014 when crude turned lower. By early 2015, crude oil prices had collapsed, but the S&P 500 stayed higher until the summer of 2015 before it corrected into early 2016.

Crude oil bottomed with the stock market in early 2016, but peaked in October 2018 at around $75 per barrel. This was well below the price levels above $100 seen in 2011-2014. Since 2018, crude oil has formed lower highs (line 3), while the S&P 500 has made higher highs despite a few sharp drops.

In the action this week, the sharply lower prices were interpreted by stock investors as a negative forecast on the economy, based on the resurgence of COVID-19. The monthly chart of crude oil shows that the rebound from the April low of $9.09 has failed to move back above its declining 20-month exponential moving average (EMA) at $46.31.

The monthly chart shows a broad downward trending channel (lines a and b). The September low at $36.66 was convincing broken on October 29th as crude oil had a low of $24.79.  The monthly starc- band for November is currently at $17.95.  The monthly On Balance Volume (OBV) has turned down from its weighted moving average (WMA) after breaking support (line c) in March.

The Herrick Payoff Index (HPI) uses volume, open interest, and prices to measure money flow. The monthly HPI has just rebounded back to its downtrend and its declining WMA. It had dropped below the zero lines in February, which was a sign that money was flowing out of crude oil. The negative signal was confirmed by the drop below the support (line e). The HPI would need to move back above its downtrend (line d) to send a more positive signal for prices.

The Energy Select (XLE) rallied as high as $31.95 on October 9, but is now down over 7% for the month as we head into the last trading day. The Wednesday October 28th low at $27.55 was below the daily starc- band, and overall the selling has been heavy this week. The relative performance (RS) has been in a solid downtrend since July, as it has continued to make lower highs and lower lows.

The OBV made another new correction low on Wednesday and is negative, but is getting oversold. It could rally back to its WMA on a oversold bounce. XLE has resistance at $29 and then the declining 20-day EMA at $30.05.

Using seasonal analysis, it has been shown that the crude oil futures tend to top and bottom during certain times of the year. Crude oil typically tops in July, while a bottom typically forms between December 14 and February 8 (see chart).

Of course, the seasonal tendencies must be supported by the technical outlook. Therefore I will be first watching for positive signals from the daily indicators that are subsequently confirmed by the weekly charts. Until that occurs, I will continue to avoid the energy ETFs and stocks.

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