Mon., Dec. 21, 2015
(Before the Market Open)
MY DEEP THOUGHTS
ON OIL AND THE ENERGY SECTOR
As you can see, YTD the stock market indices haven’t done that great, as lately, everything has correlated highly to the trajectory of oil prices, which have recently been plummeting. Plunging oil prices should be invigorating the DJ Transportation Average, but perversely that index is down by -19.43% YTD.
Here’s a chart of crude oil:
As you can see oil has been in decline for roughly nine years now, since roughly 2008, when it reached $145 per barrel (for another chart on oil, click here). Currently, crude oil is trading at $34.49 (Click here for a WSJ article on Oil reaching levels not seen since 2004). Over the past 18 months, oil has really slid downwards, making many investors worried about the energy sector, its stocks, and its fixed income. Some have speculated about many energy sector company bankruptcies. Many believe there will be consolidation, bankruptcies, further layoffs, etc. I believe there will be the slashing of dividends across the board for the entire energy sector as well (for all of it related to oil- since energy includes some sub-sectors not directly related to oil prices, etc.).
What does lower oil “hurt”? It hurts the energy sector, specifically oil related businesses, e.g. ExxonMobil, Chevron, British Petroleum, ConocoPhillips, and many many others. It also greatly impacts the economies of Saudi Arabia, Russia, Turkey, and Brazil, because they live or die by the price of crude oil. Lower oil has even taken a toll on the economy of Canada. Once oil reaches rock bottom, it could signal the bottom of the recessions in Russia (RSX), Turkey (TUR), and Brazil (EWZ), etc. and there could be major investment opportunities. Brazil has been having its worst recession in roughly thirty to thirty-five years, and its stock market, as measured by the ETF ticker EWZ, has really suffered over the past nine years.
What does lower oil benefit? Everything and everyone else! The entire U.S. economy benefits from lower oil! For example, what do you think FedEx (FDX) or UPS (UPS) thinks about lower oil? Lower oil expands their profit margins.
It’s just like when coffee beans (ETF ticker JO) decline, also at multi-year lows, it expands the profit margins of e.g. Panera (PNRA) and Starbucks (SBUX). I haven’t figured out why the gas pump shops reduce the price of a gallon of gas when crude oil declines. Coffee shops don’t re-price lower the cost of a cup of coffee when beans decline in cost. Usually, when raw material input costs decline, it boosts the profit margins of companies that use these raw materials for final products sold to customers.
Lately, many of you may have noticed that the stock markets seem to trade in tandem (or that it correlates highly) to the price of oil. This is total irrational nonsense. It seems as though, lately, when oil is trading downwards, the entire stock market trades downwards; Instead only oil and energy related shares should be trading downwards. If anything, there should be a negative correlation, or inverse correlation, of the price of oil to the stock market. This is because, lower oil is good, if not great! So, when oil trades downwards, the stock market, in my view, should trade upwards.
Lower oil is great for the economy, great for consumer sentiment, great for consumer spending, as it acts like a tax cut. The USA is not Kuwait or Saudi Arabia. It seems like when people see oil trading downwards, they irrationally “sell everything” indiscriminately. Maybe they believe that oil is a major part of the U.S. economy? They’re wrong! This irrational selling of “everything” needs to stop, and is totally illogical, irrational, and is nonsense! Click here, for a chart on the ETF USO, which is designed to match the performance of WTI as best it can.
Additionally, I’ve looked up the sector allocations of all the U.S. Broad Based Stock indices (the DJIA, the S&P500, the S&PMidCap400, the Russell 2000, and also the index formerly known as the Wilshire 5000- now the US Total Market Index), to see how much of these indices are allocated into the energy sector (which is an overstatement, because oil and gas is a sub sector of energy, which also includes e.g. power plants).
The S&PMidCap400 (via ETF ticker MDY) has just 3.04% invested in the energy sector, the DJIA (via ETF ticker DIA) has just 6.43% allocated to energy, the Russell 2000 (via ETF ticker IWM) has just 2.59% in energy, and the S&P500 (via ETF ticker SPY) has just 6.44% in energy; Lastly, the Wilshire 5000 (via ETF ticker VTI) has just 6.50% allocated to energy.
This means that if the entire energy sector and its related shares in these indices went bankrupt tomorrow, it would only have approximately 3.00% to 6.50% impact on the U.S. Broad Based Stock Indices. So, basically, people can stop panic selling when oil trades downwards.
Here, below, are the sector allocations of all the U.S. Broad Based Stock Indices:
Many have also been quite worried about the U.S. Corporate Junk fixed income markets, and their related indices, matched by ETF tickers JNK and HYG. I think these indices (and their ETFs) are currently representing great value, as they are trading at five year lows, and could, for long term investors, provide some great yield for patient investors.
If you’re looking for high yield sovereign fixed income, try tickers PCY and EMB; Which are notorious for being category fixed income leaders. Many don’t know the JPM EMBI regularly outperforms the stock market annually as well (which it has pulled off again, this year, thus far). EMB is currently up by +0.26% YTD.
Once cooler heads prevail, the stock market could be in for a major run up, as lower oil is great for the economy! Notice Kiplinger believes GDP in the USA will accelerate in the new year, this should bode well for the economy, as well as for the stock market. I believe without a recession, there will be no bear market. There is no recession looming in the USA anytime soon.
Happy Trading,
Andrew G. Bernhardt
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Here are some recent articles I thought you might like:
- http://www.cnbc.com/2015/12/18/oil-plays-the-role-of-grinch-the-year.html
- http://www.cnbc.com/2015/12/18/santoli-will-the-great-rotation-ever-pan-out.html
- http://www.thestreet.com/story/13403443/1/president-signs-tax-extenders-bill-makes-rd-tax-credit-permanent.html
- http://www.forbes.com/sites/trangho/2015/12/18/why-2016-should-be-an-awesome-year-to-invest-in-reits/?utm_campaign=yahootix&partner=yahootix
- https://www.blackrockblog.com/2015/12/20/emerging-market-debt-outperforms-this-year/
- http://blogs.wsj.com/economics/2015/12/14/a-brief-history-of-u-s-inflation-since-1775/
- http://finance.yahoo.com/news/rotate-energy-jpmorgan-picks-15-184523984.html
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