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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…
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%.
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%.
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%).
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).
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.
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. He 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.
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