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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, soon-to-expire May futures contract for West Texas Intermediate crude took a historic plunge 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.
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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.”
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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, -25.40% and energy stocks, as tracked by the widely followed SPDR Energy Select Sector exchange-traded fund XLE, -1.49%, has reached a scale that he has never seen, since the ETF (XLE) started trading in December 1998.
FactSet, MarketWatch
In early trading on Tuesday, continuous crude oil futures, which tracks the most-active futures contract, tumbled 22.7% to $15.79 a barrel, while the XLE slumped 4.0% in premarket trading.
“ “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.” ”
Over the past month, the correlation coefficient between the XLE and continuous crude oil futures has been 0.03, 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 0.00 means there is no statistical correlation.
“[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 fell 3.1% on Monday, but has soared 27.2% over the past month, while continuous crude oil futures had lost 9.7% through Monday. Over the past year, the XLE has lost 51.1% and crude futures have slid 75%.
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.
See related: Oil market in ‘super contango’ underlines storage fears as coronavirus destroys crude demand.
“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.
