Trading Nation

The energy sector is nearing a 'critical' level. Here's why.

Energy stocks tank

Energy, the second worst-performing sector in the this year, could see further pain.

Chevron, one of the top-weighted holdings in a popular energy ETF (the XLE) fell nearly 2 percent on Monday after posting disappointing quarterly earnings Friday, and Exxon Mobil and Schlumberger closed down about 1 percent each. Crude oil, which has generally moved in tandem with energy names for the last year, has fallen 2 percent in 2017.

In a note Monday, Miller Tabak managing director Matt Maley said the XLE is nearing a critical multiyear trend line that if broken could mean the energy sector "is getting quite close to a compelling decline."

In addition, some strategists noted, futures traders' crude oil positions as expressed in commitment of trader data are at historic extremes, with their longest positions on record. This is quite the contrarian indicator, Maley wrote, as the "specs" are "almost always wrong at extremes."

"In other words, there are A LOT of people on the bullish side of the boat in crude oil," Maley wrote, while "commercials" in the energy space have their largest short positions ever.

The extreme positioning gives pause to Jonathan Krinsky, chief market technician at MKM Partners, who sees downside ahead for energy.

"Now when you talk about energy stocks, you have to remember it was the best-performing sector last year, but most of that was a function of a reversal of it being the worst-performing sector for much of 2014 and 2015. And the bulk of that gain came in the early part of last year. So if you weren't overweight energy stocks by April, you missed out on most of the outperformance," Krinsky said Monday on CNBC's "Trading Nation."

And now, Krinsky said, the opposite is occurring; the XLE relative to the S&P 500 as well as on an absolute basis is beginning to break down below its uptrend line back to early 2015, echoing some of Maley's sentiment.

However, Eddy Elfenbein, editor of the Crossing Wall Street blog, likes energy at this juncture in light of recently agreed-upon production cuts from OPEC.

"I think it's just an unwinding of some of the recent trades. I mean, oil has had a spectacular year since the lows of about a year ago," Elfenbein said Monday on CNBC's "Trading Nation."

The XLE is up 25 percent in the last year. Elfenbein noted the energy sector's poor performance over the last seven weeks or so, but sees upside in roughly six months to a year as crude oil production cuts will take some time to play out.

"The key, this is the big game changer is that the OPEC cuts that they announced in November, these were the first major cuts in eight years, they're actually working. OPEC… they never cooperate. And it really is working this time," Elfenbein said, adding that such cuts had put a "floor" of sorts at the $50 a barrel level.

Still, the technicals in Krinsky's eyes don't appear promising.

"We don't think it's going to be anything like we saw in 2015, but [the] XLE probably has some more downside, lower to mid-60s," Krinsky said, adding that although the ETF is still well above its 200-day moving average, the extreme positions are reason enough to believe underperformance will continue in the near term.