Exxon Mobile - Cause for Concern?

This post will both be a lesson in Technical Analysis (TA) for those unfamiliar and a look at the price chart of Exxon Mobile (ticker XOM).

Exxon Mobile is currently the largest company by market cap in the US. It has underperformed the both the S&P 500 and XLE (proxy for S&P energy index) since the March 2009 bottom. This under performance has been dramatic since it announced its purchase of XTO Energy (a natural gas producer). The decline in XOM's price since the purchase suggests investors believe that XOM paid too much for the XTO purchase.

XOM has broken a number of key structures during 2010 that are a cause for concern that the stock could move further to the downside. Furthermore, last week XOM closed below $62 for the first time in 4 years.

Before each XOM price chart I will explain the technical analysis pattern or concept that appear on the particular the chart (BTW there is almost always more than one cycle, structure or pattern occurring on a single price chart, but I will focus on the one I see as most prevalent).

TRENDLINES
Trendlines usually connect a series of highs or lows on a price chart (all you need is two points to connect and you have a trendline). Trendlines increase in significance the more times they are touched and the length of time the trendline is in existence. A trendline on a intra day chart with 3 touches is pretty insignificant and is likely to not "work" for long, whereas a 10 year trendline with 10 touches is quite significant.

The basic theory is after two touches you can draw a line and the next time prices approach or touch the line a trader can buy the stock in anticipation that the stock will bounce off the trendline. The more times it bounces off the line the more confident the traders become that it is a winning strategy. It also reflects a constant long term price increase (or decrease).

I will start with a long term chart and then zoom into more recent times. The first chart looks at a 40 year history of XOM stock price. XOM has been rising in a well formed channel for the last 40 years until Jan 21, 2010 when it broke this key rising support trendline line (see circled point on chart below). This is a very well formed long term trendline (it is really a price channel since it has an upper resistance trendline and a lower support trendline that parallel each other).

XOM bounced off this support trendline 8 trading days in 2002 & 2003 and 13 times during the recent bear market in 2008 & 2009 (you can see those touches on the last chart of this post). This means that on all those days prices declined exactly to the the line but did not violate it to the downside and reversed and went higher. The fact that prices bounced off it 21 times out of 21 times in 10 years is nothing short of astounding. This is one of the longest running, most reliable trendlines I have ever seen. It doesn't necessarily mean the price collapses, but it is for sure a warning of potential cracks in the XOM foundation.

XOM - 40 year monthly chart

HEAD & SHOULDERS (H&S)
The Head & Shoulders pattern is one of the most reliable and known TA patterns (works 70% of the time). The standard form two shoulders and one head with a level "neckline"connecting the lows. There are many variates of more complex H&S which can have multiple shoulders or even two heads. The neckline can also be sloping upward or downward. The most reliable H&S's generally have a level or only slightly sloping neckline and are symmetrical in nature (the shoulders are even in size and duration).

When the neckline line is violated it is a signal that prices could be headed lower. The price target is the size of the head in the opposite direction. So if neckline price is $50 and the height of the head is $80, then the price target is $31.25 [in TA targets are based on percentages, so (80-50)/80 = 37.5% and 50 * (1-0.375) = 31.25]

Next is a chart of XOM over the last 5 years. It appears to have formed a complex H&S (multiple shoulders) over this period. This is a very large H&S. They are usually not over such a long period of time and are not this large price wise. You can see in the circled point on the chart below that price has broken the neckline. It broke it on May 6, 2010 - the day of the "flash crash".

The price target is $41.68 [(95-60)/95 = 36.84% and 66*(1-0.3684)=$41.68

This implies that we could potentially see a 32% decline from today's price of $61. Not good.

XOM - 5 year daily chart

BEAR FLAG

The final TA pattern I will address in this post is a Bear Flag formation (the opposite is a bull flag). A bear flag structure is one where the stock moves down sharply and then levels out or rises slowly before moving down sharply again. The flag can take the form of a channel, wedge or triangle. It is typical that the flag moves counter the direction of the impulse move. The trading strategy is to see the fist impulse move and wait for the flag to form. Once it takes shape the trader waits for the prices to break below the flag support line then short the stock. The target of the 2nd impulse move of a bear flag structure is equal to the size of the first impulse move (the moves are referred to a poles - to go along with the flag theme).

The final chart of XOM is from the past year. Amazingly there are 4 bear flag moves in this chart. Markets exhibit fractal patterns and this is a prime example.

FLAG 1: after XOM reaches it high of the year at $76.5 it makes a quick drop to $72 and consolidates in a little flag for 4 days up to $73. From here we could expect if the stock drops below $72 that it will go to $68.5 =73 - (76.5-72). It does drop and holds at $68.

FLAG 2: from 68 it slows increases in a tight channel for almost a month before breaking below this channel and resuming its downtrend. target is $62.5 = 70.5-(75.5-68). It does drop and holds at $63.5, a little shy of our target.

[note: the 2nd impulse down in Flag 2 is the one that breaches the 40 year trendline.]

FLAG 3: for the next 3 months XOM moves in a tight channel slowly higher. It is now under the 40 year trendline and grinds against the underside of the line (it is common for prices to "back test" a broken trendline), but is unable to regain it. Eventually it breaks the trendline and resumes its slide. Target of this large flag is: $57 = 70-(76.5-63.5). The stock slides to $58.5 just short of the target and finds some footing (for now). [note: technically since this is a bigger price move we should use % and not $ to calculate the move, so the proper target is really $58.10 = (70*(1-(63.5-76.5)/76.5). This is closer to the actual move as well]

FLAG 4: during the decline after FLAG 3 price forms another mini triangle flag. The price target is $58.5= 65.25-(70-63.5). The stock declines exactly to 58.5, a perfect target hit. [note that I have ignored the long tail of the flash crash in this calculation]

All 4 of these flags come remarkably close to their target. This chart almost belongs in a TA text book under bear flags.

XOM - 1 year daily chart

CONCLUSION:
The break of the 40 year trendline is cause for serious concern. Again it does not mean that the stock will decline in the near term. It could even move higher for an extended period while staying under the trendline. It would be a significant event if it could move back above this trendline. The break of the neckline of the H&S structure is even more troubling and has more dire price targets. Lastly, (as if XOM needs another negative against it) the stock closed below $62 for the first time in 4 years. The price chart does not offer many bright points other than the stock is oversold.

I will note that further declines in this energy bellwether is a direction contradiction to my thesis that the energy sector will outperform the market, but this is what the XOM chart is telling me. I am not sure how this conflict will be resolved.

Disclaimer: I am long XOM stock (although after completing this post I am not so sure why)

Energy Sector Looks Promising

US energy equities have seen a large decline (almost 20%) in the last month and appear poised for a bounce soon (I believe it has potential to be the yearly cycle low for the index). XLE is clearly oversold on a daily basis . Combined that with a bounce off a downtrend line connecting recent lows and an affinity for this index to find support at $50 (also a nice round number which humans seem to like), makes the weight of the evidence suggests a bounce is in the cards [note - I wrote this post this morning and XLE has indeed rallied hard and closed at $52. Of course follow is needed to see if today was indeed a local bottom].

Whether this leads to upside range expansion above 62 is to be seen, but if we are still in this super charged / super speed cyclical bull market then I expect that to be the case. 62 is an important price and it looks like it could move substantially higher if it can break above this level.

Remember that Energy is a late cycle performer (it topped 9 months after the October 2007 S&P 500 top and went 15% higher after that Oct 07 broad market top. In the previous bull market it also topped in mid 2001 over a year after the broad market topped in early 2000) . This means that we could see rotation into Energy & Material stocks later this year and could make Energy an out performer until the end of this cyclical bull market.

XLE - 2 year daily chart

Looking at the longer term (see chart below), XLE has potential stronger support in the 43 range, which was both the July 2009 intermediate low as well as the point on the chart where the long term support connecting the last two bear markets lows.

Also note that the market was range bound between $50 to $62 in 2006 into the beginning of 2007 before breaking out and ultimately topping at $90 in May 2008. Furthermore after this breakout $62 served as support during the intermediate lows in Aug 07 and Jan 08.

XLE - 15 year weekly chart

I would also like to look at the chart below of the performance comparison between the SPY (S&P 500 proxy) and XLE. You will clearly see that energy (yellow line) strongly out performed the S&P (purple line) over the last market cycle. In fact XLE did not even come down and test its 2001 high during the 2008 bear market. This is in stark contrast to the S&P which breached its 2003 bear market low in 2008/2009.

I would dare to say that XLE is in a secular bull market (I believe this is tied to the rise of emerging markets), whereas S&P is most certainly in a secular bear market. Clearly over two cycles energy has made a series of higher highs and higher lows. Very impressive.

XLE vs SPY - 15 year daily chart

Until next time...

First Post

Hello World! This is my first blog post.

This blog will be used to express my views on the financial market. The focus will be the application of technical analysis through of the lens of long term secular trends.

My macro view is that the world economy has reached a point where strong headwinds threaten to hold us to substandard or no growth for many years to come. This macro belief is founded in two main areas:

(1) The global economy is over levered to a point where it has become dangerously destabilizing. Both private and public debts are much too high. Even with the massive debt transfer from the private sector to the public section, the private sector continues on a path of deleverging (and rightfully so). Public promises in the US now far exceed our capability to make good on those promises. This will have a negative impact on long term growth, either through (a) austerity (sadly it probably can only be forced by the "bond vigilantes" as has recently been shown in Europe), (b) money printing and utter reckless hyperinflation (god help us all), and/or (c) massive cuts to entitlements (difficult to do considering those receiving those benefits are the strongest voting block...the old folks / boomers ). With the exception of the hyperinflation route, the other routes are all deflationary in nature. I do not believe a mature economy like the US can grow its way out of it debts as the supply side folks would have you believe (no dice Summers).

(2) Fossil fuel energy resources, especially crude oil have reached a point where global production cannot keep pace with global demand (e.g. peak oil). It is my belief that much of the industrial revolution and the growth witness over the last 150 years is a direct result of cheap abundant energy (ALL of which has been derived from fossil fuels). This cheap energy is the life blood of capitalism. The majority of production advancement of the last century has been the pursuit of technologies that use more energy and less labor; essentially advancement of the machines. The law of supply and demand dictates that stable supply and increasing demand will be come to equilibrium through higher prices. These higher prices cause demand destruction thus pricing out portions of economic production. It is my belief that until an alternative source of energy is found (highly unlikely it will be easy or cheap) that every economic advance will be met rising energy prices that will choke the economic growth. It is also my belief that the deep drop in global economic production starting in 2008 was correlated with oil reaching $147 a barrel and not the sole result of the failure of Lehman Brothers as the history of the "Great Recession" has been rewritten. Of course the housing bubble with it corresponding over leverage and therefore mountain of bad debt at the banks also did major damage.

OK, now on to some charting. We might be on the eve of something very big. Has the grandiose Keynesian dream of "something for nothing" turned into a nightmare? If we can't print our way to prosperty what other choice do the central bankers have?

I am going to start with a look at the 5 year chart of the EFA ETF. It represents the holdings of the developed world stocks ex USA. You can see in the chart below that we have failed the first attempt at downtrend line that began at the start of the 2008 bear market. After rallying all the way back to the point of the October 2008 crash the market we have seen a sharp sell off that has broken the February 2010 low. This a bearish looking chart. The volume increase on the recent sell off is especially troubling. In the short term we are oversold, but if we are entering a bear market (or maybe never left the last one) then things can remain oversold for quite a long time.

EFA 5 Year Chart

Much more to come!