Market Extra: Avoid oil stocks, as historic divergence with oil prices suggests too much volatility to risk buying, analyst says
April 22, 2020 - 7:37 AM EDT
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Market Extra: Avoid oil stocks, as historic divergence with oil prices suggests too much volatility to risk buying, analyst says
Market Extra
Oil prices and the energy sector likely to remain under pressure as demand for oil won’t return until people start driving and flying again
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The dislocation in the crude oil and oil-related stocks has reached unprecedented levels, which makes the energy sector a little too hot to handle for investors, some analysts say.
That comes as the front-month, May futures contract for West Texas Intermediate crude took a historic plunge on Monday into negative territory, as the glut of oil and the lack of storage space sent prices into negative territory, meaning sellers were willing to pay buyers to take physical delivery of the oil. There is also a big drop in demand, as the COVID-19 pandemic has reduced travel and economic activity.
Dan Wantrobski, technical analyst at Janney Montgomery Scott, said investors should watch out for “explosive moves” among energy stocks, but the charts don’t yet give a clear enough picture of which direction the sector might move. Although there is good value to be found in the sector, he indicated that the risk of a wipeout is still too high.
“For this reason, we would continue to avoid the sector while the trading landscape remains so potentially volatile for the time being,” Wantrobski wrote in a note to clients. “There is likely good value at such oversold levels, but we have yet to see signs of real stabilization in energy prices–and this may have detrimental effects on energy stocks in the weeks ahead, in our view.”
The problem is that energy stocks have been rising over the past month, despite the continued selloff in oil prices. Wantrobski said this divergence between the commodity CL00, -1.72%
and energy stocks, as tracked by the widely followed SPDR Energy Select Sector exchange-traded fund XLE, -1.76%,
has reached a scale that he has never seen, since the ETF (XLE) started trading in December 1998.
FactSet, MarketWatch
On Tuesday, continuous crude oil futures, which track the most-active futures contract, plummeted 43% to $13.12 a barrel, while the XLE fell just 1.8%.
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“Until people start driving to work again and flying/driving to recreation spots, oil will remain under pressure and the energy industry will have to face its structural problems of overcapacity and generally fragile balance sheets.” ”
— Nicholas Colas, co-founder of DataTrek Research
Over the past month, the correlation coefficient between the XLE and continuous crude oil futures has negative 0.09, based on a MarketWatch analysis of FactSet data. That compares to the correlation coefficients of 0.97 over the past year and 0.62 over the past five years. A correlation of 1.00 would mean the two always move in the same direction, while a negative correlation means they often move in opposite directions.
“[I]t is important to note that historically speaking the XLE has shown a very high directional correlation to spot prices—and we believe that such a relationship can re-emerge in the coming weeks—which implies that either crude prices have to stabilize (and experience a big oversold rally), or the equities that have thus far been buoyed by liquidity measures will need to turn lower going forward,” Wantrobski wrote.
The XLE has soared 25% over the past month, while continuous crude oil futures had dropped 45% through Tuesday. Over the past year, the XLE has lost 53% and crude futures have slid 83%.
As DataTrek Research co-founder Nicholas Colas wrote to clients Tuesday, the shape of the entire crude oil futures curve, which shows prices increasing steadily every month, suggests the crash in crude prices Monday was an “outlier” event. That said, he reminded investors that just as monetary and fiscal stimulus can’t cure COVID-19, they also can’t store surplus oil or push prices higher before demand actually returns.
“Until people start driving to work again and flying/driving to recreation spots, oil will remain under pressure and the energy industry will have to face its structural problems of overcapacity and generally fragile balance sheets,” Colas wrote.
In other words, “avoiding the sector is the most prudent action just now,” Colas said.
