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The Tell: Oil could break the stock market’s back if crude ‘goes parabolic’ — How to prepare

Oil futures are trading at seven-year highs, adding to jitters around a teetering stock market, and investors should be prepared for the possibility of a further surge to the upside, one chart watcher warned on Wednesday.

“Oil could be what breaks the market’s back if it goes parabolic here. Watch out, but also make sure you have exposure to oil in case it does happen,” wrote technical analyst Andrew Adams in a note for Saut Strategy.

West Texas Intermediate crude, the U.S. benchmark, has blown through price resistance levels that Adams said he had previously expected to give it some trouble.

“When resistance is completely ignored, there’s usually a good chance an asset is going higher, but now there is a heavier resistance area around $85 where it stalled out late last year before dropping more than $20,” Adams said. “Above there, I don’t see much resistance at all until closer to $95 and by that time we could see some real fear about oil prices weighing on consumers that are already dealing with higher prices everywhere else.

“Higher oil prices should continue to help the oil companies, but it also raises costs on many other industries and could further harm margins,” he wrote.

WTI pushed well above the $85 level in Wednesday’s session. The front-month February contract CL.1 CLG22 rose 1.8% to close at $86.96. on the New York Mercantile Exchange, its highest close since Oct. 8, 2014.

See: Oil builds on its highest price in more than 7 years as supply worries persist

March Brent crude BRN00, -0.43% BRNH22, -0.43%, the global benchmark, closed at $88.44 a barrel, a gain of 1.1%, on ICE Futures Europe, for its highest settlement since Oct. 13, 2014. WTI is up nearly 16% so far in the new year, while Brent has rallied 13.7%.

Stocks, meanwhile, have stumbled to begin the new year as Treasury yields have surged, a move attributed largely to expectations the Federal Reserve will be much more aggressive than previously expected in raising interest rates and otherwise tightening monetary policy this year.

In One Chart: Stock-market warning signal: Here’s what surging bond yields say about S&P 500 returns in next 6 months

A sharp tumble on Tuesday left the tech-heavy Nasdaq Composite  COMP, -1.15% down more than 7% so far in the new year, while the S&P 500  SPX, -0.97% declined 4% over the same period and the Dow Jones Industrial Average DJIA, -0.96%  was off 2.7%. Stocks gave up early gains to edge lower Wednesday afternoon.

Energy, however, has remained a bright spot in equities, with the sector up more than 16% so far in the new year and one of only two of the S&P 500’s 11 sectors, alongside financials (up 1.6%) in positive territory.

Oil stocks are taking a cue from crude, poised to either break out and continue the rally or take a break, Adams said. The SPDR S&P Oil & Gas Exploration & Production exchange-traded fund XOP, -1.18% is up more than 12% in the month to date, but fell 1.1% on Wednesday.

XOP is off to a great start to the year and its “big picture” chart is positive. But it’s trading at its upper volatility band and near where it ran into resistance a couple months ago — a “critical spot,” he said (see chart below).

Saut Strategy

“It’s hard for me to suggest going heavy on it and oil stocks in general here at such an uncertain point, but I continue to think pullbacks in this group are for buying and oil stocks continue to be the best source of alpha in this market,” Adams wrote.

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