Chart Advisor: Energy Under Pressure

By J.C. Parets & All Star Charts

Friday, 17th March, 2023

1/ New Lows for Crude Oil & Energy Stocks

2/ Mid Caps Make New Lows

3/ Rocky Week for Rates

4/ What Happens After Inversions?

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1/ New Lows for Crude Oil & Energy Stocks

While the weakness in the financial sector received most of the attention this week, energy stocks performed even worse, dropping nearly 7% this week to a five-month low. 

At the same time, crude oil plunged more than 13% this week, recording its worst week since it briefly fell into negative territory nearly three years ago. It broke below $70 per barrel for the first time since December of 2021, closing the week at its lowest level in 15 months.

Energy stocks (XLE) are trying to hold above their 2018 highs, but the outlook doesn’t look good for the sector with crude oil below its respective highs. Crude oil and related energy stocks are unlikely to resolve in opposite directions. If oil prices continue to fall, we could expect energy stocks to follow suit in the coming days and weeks.

2/ Mid Caps Make New Lows

The S&P Mid Cap 400 ETF (MDY) fell 2.5% in today’s session, closing at its lowest level since November.

As you can see in the chart below, price is barely undercutting the 61.8% retracement of the recent rally off the October lows.

Sellers became increasingly aggressive as they pushed prices lower this week. As long as we’re below 436, the risk would be to the downside for mid-cap stocks, and there is an elevated probability of revisiting the 2022 lows.

3/ Rocky Week for Rates

The bond market just experienced one of its most volatile weeks in history.

When it comes to the middle and long end of the yield curve, the U.S. 10-year and 30-year Treasury yields are challenging key former highs. 

As you can see, this polarity zone coincides with the June highs from last year and the pivot lows from February, making it a critical level of interest.

If yields violate this level, we could expect further strength from long-duration assets such as bonds and growth stocks in the foreseeable future. However, a bounce from current levels could keep the trend intact.

4/ What Happens After Inversions?

The 10-2-year yield spread just reversed higher in record fashion, rising at a faster pace than we’ve seen in decades. An inverted yield curve, or negative spread between shorter and longer-duration yields, is a widely-used leading indicator for predicting bear markets and recessions.

Throughout history, the yield curve has typically inverted 12 to 18 months ahead of an impending recession.

But what happens when the spread is no longer inverted? If we move back into positive territory, does that mean a recession will no longer hit?

Unfortunately, history shows that’s not the case. As shown in the chart, the selling pressure doesn’t tend to arrive for stocks until after the inversion, once yield spreads widen again.

During the last three inversions, it wasn’t until spreads started to rally higher that the stock market experienced significant downside volatility. In fact, the stock market entered a bear market following the inversions and reversals of 2001, 2007, and 2020.

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Originally posted 17th March, 2023