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ENERGY’S BIG LEAD COMES WITH A BIG WARNING

The S&P 500 energy sector .SPNY has delivered strong gains this year, but the ride has been anything but smooth. It’s up nearly 24% year to date, making it the best-performing S&P 500 .SPX sector so far, but those gains have come with plenty of volatility.

Energy stocks took off early in the year as crude prices surged amid escalating Middle East tensions, including the U.S.-Israeli conflict with Iran. The sector was up as much as 42% at a March 30 intraday record high, fueled by geopolitical risk and fears of tighter global supply.

Since then, the rally has lost steam. Despite ongoing tensions in the Persian Gulf, energy stocks have pulled back sharply, ending Friday about 13% below that March peak. Notably, the sector’s high coincided with a low point for the broader market, suggesting investors rotated elsewhere.

It’s also worth noting that while energy stocks closely tracked NYMEX crude futures CLc1 earlier in the year, with a strong rolling 50-day correlation into early March, that relationship has since weakened. Lately, energy equities appear to be responding less directly to moves in oil and more to broader equity forces, including sector rotation and company-specific moves.

The energy sector's pullback has put traders on alert. On the charts, the sector appears to be forming a classic head-and-shoulders top, a pattern that often signals a shift from an uptrend to a downtrend. It features a prominent peak flanked by two smaller ones.

For the pattern to be confirmed, the energy index, which finished Friday at 850.03, would need to fall below support around 820. A clean break could point to a technical target near 660, effectively erasing all of this year’s gains. A move above the right-shoulder high near 914, however, would undermine the bearish setup and revive the case for a push past the March high near 977.

Sharp swings are par for the course in energy, and this year has been no exception. Over the first 19 weeks of the year, the sector has ranked as the market’s best performer seven times, and its worst performer four times. Historically, no other S&P 500 sector flips between leadership and laggard status as frequently, underscoring how quickly sentiment can shift.

That volatility is magnified by concentration risk, with nearly half the sector tied up in just two stocks: Exxon Mobil XOM.N and Chevron CVX.N.

(Terence Gabriel)

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