Oil to Bears: You're Wrong
Oil strength appears to be in its early stages as a period of leadership asserts itself in the oil equipments and services industry. Further leadership in price means the negative narrative and bear trade is about to reverse.
Everything popular is wrong.
-- Oscar Wilde
Energy has been a significant laggard since early 2011 as the world became gripped with fear over Europe and a hard landing in China. As the mini-correction of May took place in the equities market, it was the commodity space which took the biggest hits, sending oil sharply lower. Yet here we are and seemingly out of nowhere, oil prices are back at the $90 level. This would seem to be at odds with the negative narrative about global growth and a coming recession. The bear argument over an end to global growth is inconsistent with the sudden rise back up in oil.
I have long argued that gradually rising oil is actually bullish for stocks as much as it is painful for consumers because it forces cost push inflation expectations back into the system. This, in turn, makes money flow out of bonds and into risk assets in a bid to simply keep up with anticipated higher fuel costs going forward. This trend may just be getting started. Take a look below at the price ratio of the iShares Dow Jones US Oil Equipment & Services ETF (IEZ) relative to the S&P 500 (IVV). As a reminder, a rising price ratio means the numerator/IEZ is outperforming (up more/down less) the denominator/IVV.
I focus on the oil equipment and services industry here because it is the area of the energy market most sensitive to oil price expectations. Notice that a sharp V-formation in strength is underway now. This could with hindsight be the start of when global growth hope returns given the sensitivity oil stocks have to the performance of emerging market equities and reflation. Either way, strength here indicates oil is likely to continue to rise alongside other risk assets.
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