There are no two ways about it: we've been fairly downbeat on the prospects for the US energy sector over the last couple of months (see "There will be blood in the energy sector" and "XLE bears have all the energy" for two examples from the past three months).
The economist John Maynard Keynes purportedly once said, "When the facts change, I change my mind. What do you do sir?" While we haven't yet changed our outlook for the sector, recent price action warrants revisiting the bearish view with a more critical eye.
Since bottoming in early July, the energy sector (NYSE:XLE) has rallied by about 5% to break meaningfully above its 50-day moving average for the first time since January. The ETF also was able to clear its 8-month descending trend line in the same area.
The sector's setup in the Relative Strength Index (RSI) indicates the breakout in the ETF itself. Specifically, XLE has put in four "lower lows" over the last two months, but each of those lows were accompanied by a "higher low" in the RSI indicator, creating a rare quadruple bullish divergence with the indicator. In layman's terms, this pattern suggests that selling pressure has been waning for months and raises the probability that a longer-term low has formed in the 63.00 area.
Source: Stockcharts.com
The energy sector is also looking stronger on a relative basis as well. When compared to the broad S&P 500 (XLE:SPY), the energy sector has also broken above its relative downtrend line off the December highs. In this case, the relative price formed a triple bullish divergence with the RSI indicator, signaling that the bears have been growing more timid on a relative basis as well.
Source: Stockcharts.com
With fundamental support from a decent earnings season to date for the sector and rising oil prices over the last six weeks, our analysis suggests that the energy sector could be due for a recovery over the next couple of months. Whether the energy sector has seen a long-term bottom remains to be seen, but as long as XLE can hold above its 50-day MA around 65.50, a continuation of the recent short-term strength is likely.