Source: TheStreet by Mike Mufson on Thursday, 12th March 2015
NEW YORK (TheStreet) -- Since last June, the energy sector has underperformed the Russell 1000 by nearly 25% and has been the worst performing sector in the U.S. equities market.
Analysis suggests that we are closer to the bottom of energy underperformance than the consensus realizes. The recent 50% decline in oil prices is historic but not unprecedented. In the past 25 years, there have been four other occurrences of 30% or more oil price declines with corresponding dramatic negative relative performance of energy stocks. In each of these cases, the sell-offs have created rewarding environments for investors to significantly outperform. The recent collapse in energy stocks is similar to others.
On average, rig counts have historically declined approximately 50% from peak-to-trough during a major downturn in oil prices. Energy stocks, however, start to outperform on a relative basis after rig counts fall just 25%. Currently, rig counts have fallen 24%. In the past four oil price downturns, energy stocks have outperformed the Russell 1000 by 1,000 basis points between the bottoming of the stocks and the bottom of the rig count.
2. Crude oil prices are stabilizing.
Not surprisingly, relative energy stock returns are correlated with the price of crude oil. During the previous down cycles, oil prices declined on average 52% over a 263 day period. The current decline registers at 55% over 255 days. Note the similarity between the historical averages.
3. Crude oil inventory still rising.
Energy stocks' relative performance improves after inventories peak. During past down cycles, oil inventories have expanded by 15% over 290 days. Currently, inventories have increased by 14% over the past 360 days. It is worth noting, however, that inventories have not yet begun to decline. While the increased supply from new U.S. land drillers is well-documented, fears of global growth contraction and concurrent declines in oil demand have contributed to declines in oil prices. Once inventories begin to draw down, this will signal that demand has stabilized and that supply-reducing measures like rig count reductions should drive sustainable increases in the price of oil.