I've been asked many times today why energy stocks are again underperforming the market. There are several explanations:
1) When oil prices go down sharply, energy stocks underperform. This is the simplest--and most direct explanation for the decline. Further, many analysts are now attempting to estimate energy stock earnings based on oil at around $60, rather than $100 where it was a few weeks ago.
2) the leverage factor is going away. Much of the outperformance in energy in the last several years has been due to hedge funds getting aggressively involved under very high leverage. On top of this, hedge funds have fewer prime brokerage firms to borrow from.
Besides a reduction in leverage, speculators are continuing to exit the market. Goldman and Morgan Stanley,who were among the largest speculative players in the oil market, cannot play to the same extent as before because they are commercial banks and cannot take the high risk profile they formerly assumed.
3) As a corollary to 2), there has been unusually tight ownership of energy--to be blunt, every fast money yo-yo on the planet was in commodities in the last 4-5 years, largely energy. Now all that is unwinding, and they are continuing to get margin calls.
4) Demand fears on global recession. There is talk of notable reductions in capital expenditures by major oil companies, which is impacting oil service companies.
- Fed's Beige Book: Economy Weak Throughout US
If this decline in oil continues, the traditional tactic for those who must trade energy stocks is to go long the biggest names. That's because the biggest names have the longest time horizons and can be most conservative.
That's why, for example, ExxonMobil is only down 15 percent this month, while most oil service names are down 30 to 40 percent. Exxon has $40 billion in cash, more stable than some countries! While ExxonMobil is down 9 percent today, the decline is small compared to the double digit declines in other energy and commodity stocks.
Take a look at Suncor, formerly a darling of the oil sands crowd; down 50 percent this month.
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