08.31.2022
This article examines XLE and asks the question, "Is now a good time to establish a long position?"
Key Takeaways
The monthly and daily charts are aligned with seasonality.
They all argue that patience here is warranted.
The increased potential reward for getting in early is not likely to outweigh the opportunity cost and increased risk of failure.
Introduction
The S&P 500 cap-weighted energy sector ETF (XLE) demanded the spotlight during the last quarter of 2020. As of 2022's third quarter, XLE has yet to share that spotlight. XLE’s outperformance begin as its relative strength line, compared to the S&P 500 ETF (SPY), bottomed the week of November 6th, 2020. Its relative strength stayed strong throughout 2021. As the broader averages peaked at the start of 2022, XLE’s relative strength line accelerated. See the following chart.
XLE Weekly. Click to enlarge.
Since XLE’s relative strength bottomed during the week ending 11/06/2020, it has gained 180.82% in value. With SPY gaining 13.72% over the same period, XLE gained 167.10% more than SPY itself.
Sector Performance since 11/06/2020. Click to enlarge.
The weekly chart above shows price’s last swing high at $93.31 in June with a shooting star type candle, and price's last swing low in July with a hammer type candle. That swing low was supported by the bulls at the 38.2% Fibonacci retracement from the Covid low. This run higher has caught the attention of many market participants who are wondering if now is the time to establish, or reestablish, a position. To think about this question, let’s first analyze a monthly chart.
The Charts
XLE bottomed in 2002 and then began a 70-month run. During that time, price gained more than 365%. Price then had a sharp correction and retraced more than 2/3rds of its prior move. That correction bottomed in 2009. From there price launched into another impressive move higher. Unable to reach its 2008 highs, price formed a 2-year coil. Upon breaking out, price ran higher for the next two years. It achieved its measured move price target and printed an all-time high in 2014. Price fell sharply again, retracing 61.8% of its move from the 2002 bottom to its 2014 top. Price then traded sideways for 4-years until the Covid plunge of 2020. From the Covid low, price ran up more than 307% in 27-months until supply overwhelmed demand around the $90 level in June. This level was also the 2008 top. It is marked with red arrows on the chart below.
XLE Monthly. Click to enlarge.
Looking at the lower pane, we can see XLE’s relative strength in a 14-year downtrend. Relative strength had a throwunder of that downtrend channel during the Covid bottom. The mean reversion from this throwunder has been the recent relative strength. It is noteworthy that despite the incredible outperformance from 2020 until now, XLE’s relative strength line has not broken out of its 14-year downtrend line.
So, is XLE is buy? It might be. While one could argue XLE just printed a lower-high in July, price looks volatile here. Price is going through the process of absorbing the supply that has been coming to market. Surely market participants who bought at the 2008 and 2014 tops are unwinding their positions, and market participants who bought near the Covid lows are taking profits. In order to get interested in a long position below the 2008 highs, I would want to see price tighten up with declining volume to show that supply has stopped coming to market. The other option would be price holding above the 2008 highs with XLE's relative strength line breaking its downtrend line. This second options is the less riskier option.
What can we learn about XLE from a daily chart? We can see price’s June high and the subsequent pullback to its July bottom. XLE's July bottom was about a month behind SPY which bottomed in June. I have attached anchored-volume-weighted-averages to both of those levels. This shows the average price for everybody who bought from those dates. Both camps are, on average, showing a profit. As of now, price remains above $80, marked with arrows, which has been a battle ground since March. Momentum has a beautiful uptrend, and relative strength has recovered its quarterly moving average.
Is it a buy now? Not really. If price pulls back to the AVWAPs and holds above them, that will make a much better entry to hopefully ride price higher in an attempt test the June high. From there, your tactics will vary based on your planned holding period. Entering now and risking just below $80 is possible, though it is riskier as price has not shown its ready to move higher right away.
XLE Daily. Click to enlarge.
The next chart, prepared by Sentiment Trader, shows seasonality for XLE looking back in time since its 1998 inception. The chart is clear, we are now entering a seasonally weak part of the year. The green line is today, 08/30/2022. While price gets much more weight than seasonality, it does appear to add a headwind and corroborate the messages of caution the monthly and daily charts are expressing.
XLE Seasonality. Click to enlarge.
Conclusion
The monthly chart is showing a volatile absorption of overhead supply from 2008 and 2014, as well as selling from those taking profits. Depending on time-horizon and risk-preference, waiting for a breakout above the 2008 highs with confirmation from the relative strength line makes the most sense for a low-risk long-term entry. Entering now before knowing if price will press above its 2008 highs adds some risk, though the reward will be greater should it work.
The daily chart has price still above the key battleground of $80, though it might fall farther to test the anchored-VWAPs from the June high and July low. The daily chart will offer a more attractive reward to risk for a shorter term trade should price pull back or if price confirms $80 as support.
Seasonality is forecasting headwinds, not tailwinds, for a long-entry now.
Taken together, the weight of the evidence argues that caution is warranted here and now. Waiting for a resolution of price, or at least a clearer message, seems best.
Should price setup better, either for a long or short position, I will write another article talking risk, tactics, and targets,.
Thanks for reading.