The energy sector is overbought. But, there’s still plenty of room for it to work even higher in the months to come.
We turned bullish on the energy sector last November. It had underperformed the S&P 500 by so much all year, we thought energy stocks were set up for a mean game of “catch up.” And now, while the S&P 500 is trading at about the same level it was at in early-November, the Energy Select Sector Fund (XLE) is up 23%.
As a result, most energy stocks are short-term overbought. They’ve run too far too fast. And, they are vulnerable to a short-term pullback – if only to relieve the overbought conditions. For the intermediate and long-term time frames, though, the energy sector is headed even higher.
Look at this chart of the Energy Select Sector Fund (XLE)…
The dramatic rally over the past six weeks has pulled XLE historically far above its 50-day moving average line (the squiggly blue line on the chart). XLE rarely strays more than 10% away from its 50-day MA before reversing course and heading back towards the line. XLE closed 14% above its 50-day MA on Friday.
Notice also how all of the various moving averages are expanded far away from each other. This condition suggests there’s not much energy remaining to fuel an immediate move higher. XLE needs to pullback a bit or at least chop around the current level long enough to allow the moving averages to coil together and build up energy for the next big move.
And, that next big move is likely to be higher.
Look at the MACD and RSI momentum indicators at the bottom of the chart. There are no signs of “negative divergence.” In other words, as XLE has been rallying, the indicators have been rallying right along with it. This confirms the uptrend. It suggests any short-term correction will likely be followed by another rally to higher highs.
Yes, the energy sector is overbought, and it is vulnerable to a short-term pullback. But, based on the setup in the XLE chart, traders should use any pullback in the sector as an opportunity to add long exposure. The energy stock rally has farther to run.
Best regards and good trading,
Jeff Clark
Editor, Market Minute