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Energy ETF XLE Struggles As Crude Oil Looks For A Bottom

The Energy Select Sector SPDR ETF (NYSEARCA: XLE ), which tracks the S&P 500 Energy Select Sector Index (IXE) and is traded in direct correlation with the WTI crude price, is on the rebound after a sell-off in early November on concerns about global crude oversupply, financial turmoil in the eurozone and China, as well as a weakening U.S. economy now that the Federal Reserve has begun hiking interest rates. Investors appear to be reluctant to step in, considering that the crude oil market remains extremely volatile and the Fed rate hike path is ambiguous. Comments and remarks from top OPEC and U.S. Federal Reserve officials usually move crude prices one way or the other. Recent remarks from Federal Reserve Chair Janet Yellen during her testimony in front of the U.S. Congress on February 11, sent the crude price plunging over 8% in just two days, to a 12-year low of $26.05 a barrel, while the yield spread between the 10-year and 2-year U.S. Treasury Notes dipped below 1 percentage point for the first time since early 2008. Investors may have a new worry about the sinking yield spread because falling spreads may indicate worsening economic conditions in the future. Since 1960, each time the yield spread went negative, a recession followed approximately 12 months later. According to Bloomberg , Willem Buiter, Chief Economist at Citigroup, sent out a note to their clients to get ready for a global recession. “The most recent deterioration in the global outlook is due to a moderate worsening in the prospects for the advanced economies, a large increase in the uncertainty about the advanced economies’ outlook (notably for the U.S.) and a tightening in financial conditions everywhere,” said Buiter in his note. Yield Spread and Crude Oil – There is no simple explanation for how crude oil prices, the U.S. dollar, and the bond yields are correlated. The general consensus is that crude oil prices move in inverse correlation with the U.S. dollar, meaning the crude oil prices would fall as the dollar strengthens, and vice versa. According to Business Insider , a 2014 report by Goldman Sachs’ Jeffrey Currie shows that such rationale has broken down in the wake of the American shale revolution. Currie explained that the U.S. net imports of crude oil have reduced significantly since 2008, as U.S. shale production has surged. This has “significantly reduced the correlation between commodities and the U.S. dollar,” said Currie in his report. Click to enlarge Since early 2014, the WTI crude price has shown a direct correlation with the yield spread between the 10-year and 2-year U.S. Treasury Notes, meaning the crude oil prices have been falling as the yield spread narrows. A simple explanation would be that investors have backed off risky assets, including equities and commodities, on fears of a looming economic slowdown, sending yield spreads lower. As the Fed continues its path of aggressive rate hikes, the 10-year and 2-year yield spread will move towards zero, which puts downward pressure on crude prices. Click to enlarge From our technical viewpoint, the 10-year and 2-year yield spread began tumbling from the 1.77 percentage point level when Fed Chair Janet Yellen made comments on July 15, during her semiannual testimony in front of the U.S. House Financial Services Committee, that the Fed was going to raise interest rates between September and December 2015. The 10-year and 2-year yield spread has fallen over 40% since then and is now supported by the lower trendline of a descending wedge chart pattern at 0.99 percentage point, or the 61.8% Fibonacci retracement level. If the trendline support doesn’t hold, the next support will be at 0.86 percentage points. In the event of a 10-year and 2-year yield spread rebound and a descending wedge chart pattern breakout for the price of WTI crude, a bottom could be in for crude oil. It might be a long shot though, as there is a major head resistance for the 10-year and 2-year yield spread at the 1.2 percentage point level, and several top Fed officials are still calling for aggressive rate hikes. Fundamental and Technical Overview – About 42.98% of the holdings in the XLE ETF are the three big cap oil, gas and energy equipment and services companies, Exxon Mobil (NYSE: XOM ), Chevron (NYSE: CVX ) and Schlumberger (NYSE: SLB ), with a combined market cap of over $590 billion, as of February 25. Click to enlarge Technically, the XLE ETF broke through the neckline of the head and shoulders chart pattern at the beginning of the year and overshot the downtrend channel. The XLE plunged to $49.93, but bounced off before retesting the October 2011 low of $49.63. Since then, the XLE has been moving in a bullish ascending triangle chart pattern, with a head resistance at around the $58 level. A breakout event could require the WTI crude oil price to move from the current level to between $35 a barrel and $37.50 a barrel. Exxon Mobil – As of February 24, Exxon Mobil has a weight of 20.18% in XLE. Exxon Mobil Corporation announced revenues and earnings for the fourth quarter 2015 that beat consensus estimates. The company said it expects to cut capital spending by 25 percent in 2016 and suspended its long-standing share buyback program. In early February, Standard & Poor’s threatened to possibly cut Exxon’s credit rating, one of only three corporate holders of a AAA bond rating. Analysts have raised concerns about the lack of information on the details of operating cost reductions and capital spending in Exxon’s earnings announcement. Roger Read, oil analyst at Wells Fargo Securities told CNBC, “How much are you cutting your spending, what are you going to do to maintain the strength of your balance sheet, and where is production going?” “You didn’t really get any of that with this press release,” he said, but noted that Exxon typically delivers that data at its analyst meeting in March. Click to enlarge In our technical viewpoint, XOM decoupled from XLE in early December and has been moving in a symmetrical triangle chart pattern. Shares of Exxon Mobil broke through the 200-day moving average in early February and are now testing the upper trendline resistance of the symmetrical triangle. A reverse head and shoulders chart pattern, with a neckline at the $83 level has emerged. A breakout of the symmetrical triangle could take XOM to the $90 a share level. Chevron – Chevron has a weight of 14.44% in XLE. Chevron reported a fourth quarter 2015 loss, despite Wall Street’s expectations for a profit, citing plunging oil prices that eroded profitability across all its divisions. The bulk of Chevron’s losses came from its divisions that explore for and produce oil and natural gas. Standard & Poor’s also downgraded Chevron Corp. earlier in February. “We’re taking significant action to improve earnings and cash flow in this low price environment,” John Watson, Chevron’s chief executive, said in a press release. To meet its goal of slashing capital spending by 24 percent in 2016, Chevron has reduced headcount, canceled drilling projects and frozen dividend payouts. The company has reiterated that the dividend remains its top priority, which will put more pressure on shares. Click to enlarge From a technical viewpoint, similar to XOM, CVX decoupled from XLE in early December and has been moving in a symmetrical triangle chart pattern. Shares of Chevron are still trading under the major moving averages, which act as head resistances. CVX could pull back to $80 and $77.50 a share, if it fails to break out of the symmetrical triangle. Schlumberger – As of February 24, Schlumberger has a weight of 8.37% in the XLE. Schlumberger reported fourth quarter 2015 earnings that beat expectations with revenues that were in line with analysts. The company faced a continued decline in rig activity, project delays and cancellations and other problems stemming from lower oil prices with no signs of pricing recovery in the short to medium term, it said in its earnings statement. In its press release, Schlumberger announced a new share repurchase program of $10 billion and that it approved a quarterly cash dividend of $0.50 per share. Click to enlarge Technically, shares of Schlumberger are traded along with the XLE ETF. The decoupling of SLB from XLE in early February could be an aberration, meaning SLB could pull back. There are multiple head resistances, including the 200-day moving average, to overcome before the stock can move higher. Conclusions – XLE, the Energy Select Sector SPDR ETF, which tracks the S&P 500 Energy Select Sector Index and traded in direct correlation with the WTI crude price, is on the rebound after a sell-off on concerns about global crude oversupply, financial turmoil in the eurozone and China, as well as a weakening U.S. economy. Since early 2014, the WTI crude price has shown a direct correlation with the yield spread between the 10-year and 2-year U.S. Treasury Notes, meaning the crude oil prices fall as the yield spread narrows. In the event of a 10-year and 2-year yield spread rebound, a bottom could be in for crude oil. The 2-year share performances of the three largest holdings in the XLE ETF, Exxon Mobil, Chevron and Schlumberger are similar to that of XLE. Decoupling of the share performances of Exxon Mobil and Chevron and the XLE ETF started to appear in December. The decoupling of Schlumberger and the XLE shares could be an aberration. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Does The S&P Really Need Higher Oil?

The steady drumbeat of lower and lower Crude Oil prices continues. With the S&P 500 struggling to hit new highs in 2015, much of the blame has been placed on lower Oil prices. Do stocks really need higher Oil to perform well? The steady drumbeat of lower and lower Crude Oil prices continues. Oil’s fall from its peak in 2014 is up to an astounding 67%. This is fast approaching the largest decline in history, the 68% drop during the financial crisis of 2008-09. (click to enlarge) With the S&P 500 struggling to hit new highs in 2015, much of the blame has been placed on lower Oil prices. If only Oil prices were higher, say the pundits, stocks would be soaring. But how accurate is this story? Do stocks really need higher Oil to perform well? Let’s take a look back at history. We have data on Crude Oil (Generic First Futures via Bloomberg) going back to March 1983. The monthly correlation to the S&P 500 since then? Essentially zero (.05). Looking at the rolling 1-year correlation, we can see there are times where Oil and equities are positively correlated and other times when they are negatively correlated. (click to enlarge) During the financial crisis of 2008 and its aftermath, the correlation between equities and Crude became more consistently positive and higher than in prior cycles. Why? A deflationary, depression-like collapse was the major fear in 2008, and lower Crude prices that year were said to be a harbinger of bad things to come. When that theory did not materialize in 2009, the opposite was said to be true. The rally in Crude was thought to be a positive, indicating reflation and stronger global growth. This relationship would persist until 2014 when Crude began its most recent collapse. Since then, while equities have struggled to hit new highs, there has been little overall correlation with Oil. This is more in line with history, as evidenced by the table below displaying calendar year returns in Crude Oil and the S&P. Some thoughts on their unpredictable relationship: From 1984-87, Crude declined every year while the S&P advanced. The S&P continued to advance in 1988 and 1989 while Crude rebounded. Then, in 1990, the S&P experienced its only down year in the 1982-99 period while Crude Oil was up 30%. From 1994-96 the S&P and Crude moved up together. From 1997-98, Crude declined while the S&P experienced two strong years. The 2000-02 Bear Market in stocks displayed no obvious correlation to Crude. From 2003-07, Crude and the S&P rose together during the commodities boom. In the 2008 deflationary collapse, they declined together and during the 2009-11 reflation they rose together. In the past two years, as Crude has suffered one of its worst declines in history, the S&P is higher. So do U.S. stocks really need higher Oil prices to generate a positive return? The answer based on the historical evidence is clearly no. Why? Because it is not clear exactly what a higher or low Crude price means for the overall economy and an S&P 500 Index where the Energy sector which comprises less than 10%. Most studies show that the U.S. economy (and U.S. consumer), as a net consumer of commodities, ultimately benefits from lower Oil and Gas prices. Similarly, companies outside of the Energy spectrum benefit from lower input costs. Ultimately, the correlation between Crude and stocks depends on why Crude is moving higher and lower, which is difficult to ascertain in the moment. It only becomes clear in hindsight. Certainly a crash in Crude as we saw in 2008 which was an indication of a collapse in global demand was not going to be a positive for the U.S. equity market. However, a crash in Crude due to increasing supply and alternative forms of Energy could very well be construed as positive for markets. Is that the case today? Again, we’ll only know in hindsight. Ironically, while the fear of the day is over lower Crude Oil prices, historically the opposite situation has been more harmful for markets and the economy. If we look back at history, 1-year spikes in Crude above 90% occurred in 1987, 1990, 2000, and 2008. All of these spikes were associated with equity Bear Markets and the 1990, 2000, and 2008 spikes associated with U.S. recessions. So perhaps the greater fear should be not a continued slide in Crude but a spike higher. (click to enlarge) That is not to say that some stability or a bounce in Crude in 2016 would not be welcomed by U.S. stocks. It most likely would if the rise could be attributed to an increase in global demand. But predicting whether and why Crude rises and falls is not an easy game to play. Harder still is predicting its impact on stocks. This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing. CHARLIE BILELLO, CMT Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mitial funds nd separate accounts. He is the co-author of three award-winning research papers on market anomalies and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors previously held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms. Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant certificate.

OIL – Buy It Here Post EIA Release

Summary I have noticed a trend in oil trading around the EIA Petroleum Status Report release. The data showing an ongoing build in inventory to record high crude oil levels reassures energy bears and resets energy prices lower this time each of the last two weeks. Longer term investors are looking forward to an eventual end of oil inventory build, and are setting a floor for oil prices. I would use this weakness to buy into the iPath S&P GSCI Crude Oil ETN and other relative investments for the long-term. Over the last two weeks I have noted a trend in oil prices that can be exploited by investors and traders alike. Oil prices have slipped each of the last two weeks heading into the EIA’s Petroleum Status Report, on fear that the inventory data might show large inventory builds. However, once the report is released, despite it’s showing of inventory build, oil prices have found some support likely from long-term investors looking to forward developments. As a result, there’s an opportunity for entry in the iPath S&P GSCI Crude Oil ETN (NYSE: OIL ) here. 1-Month Chart of the OIL at Seeking Alpha The one-month chart of the iPath S&P GSCI Crude Oil ETN shows a recent double-dip. For each of the last two weeks, oil prices and the shares of the OIL ETN have dipped ahead of and into the EIA Petroleum Status Report . The reason for concern is a greater than expected build in oil inventory, which strengthens the glut argument and forces oil prices lower. This week’s data followed trend. The EIA Report Just like last week, this week’s data for the period ending February 6 showed another build in oil inventory. The EIA Report shows that crude oil refinery inputs averaged 15.6 million barrels per day, which was 20K more than the prior week. Crude oil inventory increased by 4.9 million barrels through the week. Importantly, at 417.9 million barrels, crude oil inventory stands now at its highest point in at least 80 years and likely its highest level in history. This news again reinforced the argument about an oil glut, and it gives reason for lower oil prices and lower distillate prices, like gasoline. Thus, once again, fear of this news and the realization of this news drove a dip in the price of oil. Just after the report was released, WTI Crude futures were down 2.5% and Brent Crude was down 3.0%. The iPath S&P GSCI Crude Oil ETN was off 2.8%, but had come up off its lows. The United States Oil ETF (NYSE: USO ) was down 2.5%. Last week, oil prices moved higher off the lows set around the data release and they appear to want to do the same this week. Already crude oil futures have hemmed in their losses. Why is that? It’s because energy experts see this crude oil build ending eventually, at which point inventory can begin to see draws instead of builds, and the level of inventory can come off its high. It will eventually happen, because the rig count is coming off as we flirt with the level of oil prices where drilling is no longer profitable for the average driller. The least efficient of drillers are being squeezed out of the market as well, and so supply should come off. Even the largest of energy sector players are now reducing workforce (see my report on Halliburton ). So as producers of oil cut back, the flow of crude into inventory must come off to meet demand levels. This makes a long-term argument for the purchase of energy sector issues, especially those tracking the commodity here like the OIL ETF. The oil stocks have already enjoyed a significant burst higher, but they are now dealing with news of layoffs and earnings estimate reductions, and eventually disappointing earnings results. The OIL ETF gives investors a vehicle now to avoid all that noise and still benefit from the long-term recovery of oil prices on continuing global growth and a lesser supply environment to meet demand. In conclusion, I think you can use this bad news event as an opportunity for best entry to buy the OIL ETF security and other relative investment securities for the long-term. I am following energy closely now and so my column might prove valuable to relative interests. Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in OIL over the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.