Caution, caution, caution. That's been the messaging across June, and here we are today looking at the sell-off in energy stocks. Truthfully, the sell-off this week took many of us by surprise, but markets are tough and moments like these show precisely why it's so tough.
Before I share my thoughts on where energy stocks are headed, you need to first understand an important difference between where an energy stock is headed fundamentally and where it's headed technically.
For the next few months, a lot of things are not going to make sense on a fundamental basis. For starters, WTI is still above $100/bbl and will likely remain here for a while longer on the heels of low oil inventories around the world. Second, energy companies are going to be generating an insane amount of free cash flow at these oil prices. And lastly, the extra free cash flow will be given back to shareholders either through dividends or share buybacks. Either way, the money is coming back, so fundamentally, energy stocks remain a buy.
But this does not mean you go lever long energy stocks and YOLO into call options. Just because oil prices will remain above $100/bbl doesn't mean energy stocks will keep going up. This is where the technical and sentiment part kicks in.
What happened this week in energy stocks is a classic blow-off technical pattern. Sudden and large reversals like this usually signal a trend shift in the medium-term (3-4 months). As a result, while fundamentals might be trending bullish, we are likely headed lower/sideways for a while on energy stocks. During this time period, please do not be frustrated at the lack of price participation in energy stocks in relation to oil. It's not supposed to make sense, so don't try to make sense out of it.