By Jacob Sonenshine
Oil stocks have enjoyed an impressive rally, and they are unlikely to gain much more.
It starts with the price of oil. West Texas Intermediate crude, or WTI, has risen 12% to about $83 a barrel since mid January, boosting the stocks even faster.
Crude oil's rise is rooted in a couple of factors. The economy has continued to grow faster than expected, lifting expectations for short-term oil-and-gas demand. The fact that Israel and Iran have directly attacked each other, raising the risk of a broader war that could threaten the supply of oil, has added to the gains.
Oil's rise has sent the Energy Select Sector SPDR exchange-traded fund, home to oil producers such as Chevron, Exxon Mobil, ConocoPhillips and others, up 22% since its mid January low point. As the price of oil rises, sales for producers increase, and the market assumes an even greater increase in earnings because the producers' costs don't change much.
But now, the oil ETF has pulled well ahead of crude, to a point that historically hasn't left much room for additional gains for the stocks. The fund is in the mid $90 range, a level it last reached in 2014, when crude oil was at $93, according to FactSet. That suggests that in order for the oil stocks to keep gaining, the price of oil needs to sprint higher.
To be sure, oil equity analysts are still lifting their forecasts for earnings, but the gain in oil stocks has probably anticipated much of the effects of that.
Matador Resources, an $8.2 billion oil producer, reported higher revenue and earnings than analysts expected after the market closed on Tuesday. That was partly because oil prices were slightly higher than expected, but also because the company produced more than analysts had forecast. So gains in the stock on Wednesday were partially because of the company's unique success, rather than moves in the oil market, a dynamic that Siebert Williams Shank analyst Gabriele Sorbara highlighted in a research note.
Other oil stocks are already losing steam. The oil fund was in the red for most of Wednesday before the broader stock market erased some losses and the oil fund inched narrowly into the green. That isn't a ringing endorsement of these stocks.
At $96, the oil fund is close to its 2014 record closing high of about $101. When it hit that point, it went on to drop by a double-digit percentage to a low point in 2016.
Putting that into today's context paints a negative picture for the stocks because the price of oil may have a difficult time charging higher . On days when there isn't much news on the geopolitical front, oil doesn't inch higher, it drips lower, suggesting that selling pressure is starting to overwhelm buying interest.
Wednesday, the price was down by a few tenths of a percent.
Meanwhile, the recent rise in market interest rates, a response to the fact that the Federal Reserve sees too much inflation to lower its target for the federal-funds rate, threatens to eventually reduce demand for goods and services. That would hurt the price of oil.
"WTI crude oil may have peaked at about $85 a barrel," wrote Bloomberg Intelligence senior commodity strategist Mike McGlone, who cited rising rates as a significant threat to the price of oil.
This is all makes oil stocks look as if they are more likely to fall than to rise. The fact that many investors have already benefited from large paper gains in oil stocks, giving them reason to sell to lock in those profits, adds to the case for selling as well.
Investors who choose to sell can use the cash to buy stocks that are beaten down. There is no shortage of names to pick.
The Invesco S&P 500 Equal Weight exchange-traded fund, which reflects moves in a wide range of stocks rather than the huge tech companies that dominate the S&P 500, remains 4% below the record high it hit in late March. Stocks in many sectors have been beaten up because of disappointing growth in China, so their shares now reflect lower expectations for earnings. That makes them better bets than oil stocks.
Sell oil and buy something else. Sometimes, investing is that simple.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
April 25, 2024 03:00 ET (07:00 GMT)
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