Look for Pullbacks in Pumped-Up Oil Refiners

(Barron's; 11 Feb 2013) While shares of oil refiners have been outpacing the broad market since 2010, many of them have been really pumped up since last May. While the stocks now are technically overbought for the near term, long-term chart trends remain positive. That suggests an opportunity is coming to buy a price dip.

For example, HollyFrontier (ticker: HFC) moved higher in a relatively tame rising trend after breaking out last June (see Chart 1). Chart watchers will point out that prices advanced within the confines of a rising trend channel, which is simply a rising trendline drawn through price lows and a parallel line drawn through price highs.

Trend channels can indicate a more orderly rally than a trendline alone as they tamp down on exaggerated price swings within the rising trend. But when prices move outside a channel we can quickly surmise that something changed. A breakdown, of course, would be bearish and indicate a possible reversal in trend. Conversely, a move above a rising channel would indicate an accelerated trend, and that means pullbacks become very shallow. Investors must act quickly to join in on the rally.

But such speed can quickly push a stock too far, too fast, leaving it overbought, or overextended, and ripe for a sharp correction. That is where HollyFrontier is now. Momentum indicators such as the relative strength index (RSI) are at very high levels. While this does not automatically result in a correction, it greatly increases the risk of chasing the stock higher.

A dip back down to the top of the former trend channel is a good place for late bulls to look for an opportunity to buy. Based on current trading, that could take as much as a 10% decline. It sounds big; but in the context of a doubling of price since last June, it is quite reasonable. Given the strength in HollyFrontier to date, however, it does not seem likely the stock will pull back quite that much before eager bulls jump back in.

Tesoro (TSO) is in a similar situation with an accelerated rally and overbought momentum indicators. Making it even more risky is that it has moved 54% above its own 200-day moving average (see Chart 2). Considering that this moving average is used as a proxy for long-term trend, we can see how the stock has indeed gotten a bit ahead of itself. Anything trading too far away from its major moving average is prone to a snapback.

Further, Tesoro has reached an upside price objective derived from its 2011-early 2012 trading range. By projecting the height of the pattern up from the breakout point, we can find a likely price zone at which the rally may run into problems. If the stock survives any selling pressure that arises, it often moves higher again by a similar amount.

In rough terms, Tesoro's range was between 18 and 30, so the first target was 12 points higher, at 42. The second target was another 12 points higher at 54 and the stock traded Monday at 54.34.

Again, long-term trends remain strong, so any pullback should provide investors with a better price at which to buy.

There are several other stocks in the group with similar technical conditions. Western Refining (WNR) is a smaller stock but its trend, following a pullback, looks just as strong. And larger stocks, such as Phillips 66 (PSX) and Marathon Petroleum (MPC), offer potential buys following pullbacks and sport single-digit price-earnings ratios (on trailing 12-month results) to make them interesting from the fundamental side as well.

Refiners:

• Marathon Petroleum (MPC)
• Western Refining (WNR)
• Phillips 66 (PSX)
• HollyFrontier (HFC)
• Tesoro (TSO)