Trading Oil Via Strong Energy Stocks

Crude oil is a primary barometer of risk appetite and as such it can confirm or deny the US economy's potential to slip into recession. In the 2008-09 recession and corresponding market meltdown, oil touched $35, as ridiculously cheap a price as some fantastic companies were trading for.

During the heightened volatility of the first week of August, when the S&P 500 touched 1,100, WTI hit $75 and quickly rebounded back above $80. If you believe that the chance of a mild recession has been priced-in to equities, you may equally consider that crude oil is also signaling the economy is still in good shape.

And for broader perspective, consider that energy in general is in a long-term secular bull market, as "peak oil" may not be priced-in. In other words, it's quite possible that the average price of oil over the next decade will be well over $100.

Granted this is driven both by population growth in Emerging Markets and a weaker dollar, in addition to supply forecasts. And economic cycles will still impact the price regardless of long-term demand drivers. But the story remains a big picture trend without many meaningful alternatives.

Trading #1 Energy Stocks

In the second week of August, I mentioned this story as the fundamental backdrop for picking strong energy stocks while they were on sale. In "Energy Stocks to Buy if Oil Bottoms at $75" I highlighted seven names that all carried the Zacks #1 Rank (strong buy) for their earnings momentum.

It's a good time to revisit that list and see which stocks have done well and which ones are struggling. All but one have kept the coveted Zacks #1 Rank. And it's worth noting that more than half of the names are oilfield service companies, providing the "guns and bullets," as I like to call it, to E&P companies and refiners in the oil wars.

National Oilwell Varco (NOV - Analyst Report): This big dog of the oilfield services patch hit $60 on August 8 and rallied a week later with the market above $71. The retest of the lows was encouraging as the stock did not make new lows August 23. It now sits above $65 during Monday's rally and seems to be tracking the broad market well.

Cabot Oil & Gas (COG - Analyst Report): Cabot swung from $58 to $74 rebounding off of the first leg down, and has shown some remarkable strength on the next pullback as it held above $65 and as of lunch time today is pushing above $72.50.

Precision Drilling (PDS - Snapshot Report): This one did make new lows below $11 on the second leg down, but is trading now above $13. The last run up was capped by its 50-day moving average around $14.50.

Oil States International (OIS - Snapshot Report): Same story here as PDS... new lows during the week of August 22 near $57, but today back above $63. The 200-day moving average just above $71 was resistance on the rally the week of the 15th.

Complete Production Services (CPX): Another one that made new lows in the $24 handle, today trading above $28 and targeting its 200-day moving average just above $30, which it was able to close above on August 15.

Key Energy Services (KEG - Snapshot Report): Depending on how you look at the chart, Key is either struggling the most, or had the most strength to give away. What I mean is that it was one of the few stocks to hold up well near its 200-day moving average ($14.90) during the first decline.

After making new lows, it seems to struggle now between its last swing lows at $12.50 and $14. It was also the one name to slip to a Zacks #2 Rank (buy). This should not be taken as a sign of weakness, as only 220 names can earn the #1 spot on any given day and often there is a bit of movement back and forth among strong stocks if their earnings momentum remains competitive.

Basic Energy Services (BAS - Snapshot Report): Same story as most above... new lows below $19 and now showing strength as it pushes toward $22 with the 200-day moving average at $23.

Two Improving Oil Names

I also threw in two extra stocks worth keeping an eye: Suncor and CVR Energy. Both have gone up a notch on their Zacks Rank, from #3 (hold) to #2 (buy), and from #2 to #1 (strong buy), respectively.

Suncor (SU - Analyst Report) is down over one-third from its highs earlier this year above $45 and appears to be finding support near $30. But as an oilsands E&P company, its margins are especially sensitive to the price of crude since it's production costs are so much higher than conventional drillers.

CVR Energy (CVI - Snapshot Report) price performance makes it the only one of these nine stocks on par with Cabot Oil & Gas, as it not only did not make new lows on the market test of support, it held up very strong. In fact, its chart looks even better, with August 8 lows near $19, a second pullback to only $23 and then a current surge above the August 15 highs around $27.

Stick with the Long-Term Energy Trend

My view of playing these energy stocks is to buy the strong ones on dips. It helps to have a view of the economy that tells you where you are wrong and a recession looks inevitable, or if stocks are at least due for another fear-driven discounting. Meanwhile, the price of WTI crude can tell you a lot too. I'm watching the $80 level as make or break for a recession.

Besides focusing on smaller companies like these with earnings momentum, you also expose yourself to buy-out potential. With energy assets in ever increasing demand, both American and Chinese mega-cap companies will likely continue to gobble up smaller players.

Disclosure: I have long positions in NOV, SU, CVI, and BAS.

Kevin Cook is a Senior Stock Strategist with Zacks.com

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