Why Energy May Start To Follow Other Stocks & Why That Isn’t Good News

As the Fed and other central banks around the world have raised rates, some areas of the stock market have posted big losses. Tech, for example, and anything to do with the worlds of crypto and the blockchain were hit hard at the end of last year, and while there has been some kind of a bounce in the early part of this year, even that is looking suspect now after this week’s acceptance by Fed Chair Jerome Powell that “higher for longer” is now expected.

Energy, though, has moved in the opposite direction, gaining strength as other sectors suffered last year, then giving back some ground as other stocks recovered. That is not a coincidence. What was sold were things with intangible value, things like growth and the potential of speculative gains, and oil, as something tangible with a real-world use case, is just about the opposite of that. Still, if Jay Powell is to be believed in that he will inflict pain on the US and even the world’s economy if that is what it takes to get inflation under control, then that inverse correlation is about to break down. Oil is sensitive to overall economic conditions, and the economy has held up well so far, but if they deteriorate rapidly, the stock market will give early warning signs, and energy stocks won’t escape the negativity.

So, energy investors can no longer ignore the broader stock market and sit smug, making money as others lose. They have to start paying attention to stocks in general, and the signs there right now are not good.

For starters, the Treasury yield curve is still inverted, with the 2-Year yielding almost a full percentage point more than the 10-Year. That indicates that bond traders, the most clued in group when it comes to overall economic conditions, are expecting rates to keep rising to the point where they do damage, necessitating cuts in the future. Basically, Treasuries are indicating a good chance of a recession.

So far, of course, the economic data haven’t pointed towards a collapse. The jobs market is still quite strong and inflation numbers like CPI and PPI are still climbing, albeit at a slower rate than previously. The problem, though, is that those data are always behind the curve, and the danger is that a “data dependent” Fed won’t see the need to slow the pace of hikes, let alone pivot to cuts, until the damage is already done. Over the next few weeks, the stock market is likely to get increasingly nervous about that and lose ground and, as I said, this time energy won’t be a place to hide.

A real slowing of the US economy and the prospect of an actual recession, will have a big negative impact on expectations for oil demand, and in a market that has been trading in a narrowing range for a while, indicating balance, that will have a big effect.

Don’t get me wrong, it isn’t time to panic, nor am I saying that energy investors should abandon their long-term holdings that have done so well for them over the last couple of years. It is just that trimming some of those positions and taking some profit might be a good idea at these levels, and I for one certainly won’t be adding to my energy portfolio until the stock market has settled and the direction of the economy is much clearer.