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At the end of the first quarter, Crude Oil was up 7.5% while Energy stocks were down 6.1%. How unusual is such a divergence? Let’s take a look…
Note: References to Energy/Energy Stocks/Energy Sector throughout this post are referring to the S&P 500 Energy Sector ETF (XLE), total return data from Stockcharts.com.
Since the inception of the Energy sector ETF (XLE) in December 1998, Crude Oil and Energy stocks have moved in the same direction on a rolling 3-month basis roughly 74% of the time. On a rolling one-year basis this moves up to 76%.
Why don’t they move together 100% of the time?
At the end of the day, Energy stocks are still stocks, and they have actually exhibited a slightly higher correlation with the S&P 500 (0.62) than with Crude Oil (0.57). Energy and Crude often move in the same direction, but often is far from always.
Another important factor is volatility. At 32.6% annualized, Oil is much more volatile than Energy stocks at 21.4%.
Note: Crude Oil stats are continuous futures data via stockcharts.com. SPY and XLE stats are total return.
On a rolling 3-year basis, Oil volatility has always exceeded the volatility in Energy.
The moves in Crude Oil often dwarf those in the Energy sector, as evidenced by down capture and up capture statistics. The energy sector has had 43% of the downside of Crude Oil on average and 30% of the upside. As compared to the S&P 500, the Energy stats are much closer, with 93% of the downside and 98% of the upside.
Another way to illustrate the large difference in volatility is to look at the 20 worst monthly declines for Crude Oil. During these months Crude Oil averaged a return of -16.3% versus a return of -4.9% for Energy.
The worst drawdown in Crude (-76%) has far exceeded the worst drawdown in Energy (-53%).
How does the performance of Energy stocks compare to the underlying commodity?
Energy tends to outperform the commodity during down periods for Crude Oil.
On the flip side, Energy tends to underperform the commodity during up periods for Crude Oil, particularly in the largest up years (1999, 2002, 2007, and 2009).
We can observe this tendency by comparing a ratio of Energy to Crude Oil to Crude Oil itself. During the largest up spikes in Crude Oil (ex: 2006-08), we see a declining ratio (Energy underperforming) while during the largest downward moves in Crude Oil (ex: 2014-2016) we see a rising ratio (Energy outperforming).
How do changes in Crude Oil affect the relative returns of Energy stocks?
The best relative performance historically has occurred during periods in which Crude Oil is sharply advancing while the worst relative performance has occurred during periods in which Crude Oil is sharply declining.
In 2004 and 2005 when Crude Oil advanced 33.6% and 40.5%, Energy stocks would outperform by 21.1% and 35.3%
In 2014 and 2015 when Crude Oil declined 45.6% and 31.0%, Energy stocks would underperform by 22.1% and 22.7%.
Energy has been struggling relative to the broader stock market since Crude Oil peaked back in the middle of 2008.
What is the relationship between Energy stocks and Crude Oil?
Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of four award-winning research papers on market anomalies and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors and previously held positions as a Credit, Equity and Hedge Fund Analyst at billion dollar alternative investment firms.
Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and also holds the Certified Public Accountant (CPA) certificate.
In 2017, Charlie was named the StockTwits Person of the Year. He is a frequent contributor to Yahoo Finance and has been interviewed on CNBC, Bloomberg, and Fox Business.
You can follow Charlie on twitter here.
Pension Partners, LLC is a federally registered investment adviser under the Investment Advisers Act of 1940. Registration as an investment adviser does not imply a certain level of skill or training. The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser. For more information about Pension Partners please visit: https://adviserinfo.sec.gov/ and search for our firm name.
The information herein was obtained from various sources. Pension Partners does not guarantee the accuracy or completeness of such information provided by third parties. The information given is as of the date indicated and believed to be reliable. Pension Partners assumes no obligation to update this information, or to advise on further developments relating to it.
Past performance is not indicative nor a guarantee of future results.
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