Oil is Breaking Out and Energy Stocks Have Lots of Upside
As the famous Yogi Berre once said, “You can learn a lot just by watching”. At the moment we are watching the price of oil break out of a trading range to the highest level in about 2.5 years. The “common knowledge” explanation for the breakout is that leadership in Saudi Arabia is consolidating power and preparing the markets for a successful IPO of Saudi Aramco by keeping a lid on production. Or, there is the investment case we’ve been making all year (here, here, here and here), which is that energy capex has been slashed, oil finds are at generational lows, inventories are improving, and demand keeps ticking higher. Either way, if you like what you see in the oil markets, then you’ll love what you see among energy companies.
For example, even though the price of oil bottomed in early 2016 and now appears to be breaking above an important resistance level, energy stocks haven’t really played at all. The below chart shows our regression model of the energy sector’s relative performance and the price of Brent crude oil. The current relative performance level of the energy sector is far below what the model would predict, about 20% lower to be exact. That is to say, for global energy stocks to get back to a trend level of performance given the price of oil, they would have to outperform by 20%.