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How to know when oil prices will cause a recession, what to invest in

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This is the national average a gallon of gasThe stock market was on edge when the largest crude oil producer in the world waged the first European land war since WWII. Investors should be paying attention to crude oil prices as well as energy stocks, which have hit their highest since 2008. The stock market is forced to ask: are energy stocks, who have experienced a tremendous run since the pandemic bottom? The related question, however, could distract them before they continue: Will high oil prices trigger a recession

Bespoke reported last week that WTI crude oil had risen just 20% over the past week. This is one of five times in which crude has risen more than 20% per week. According to Bespoke, three of the four prior periods when prices spiked were during recessions.

Rystad Energy, one of the top global energy sector consulting and research firms, expects a plunge in Russian oil exports of as much as 1 million barrels per day — and limited Middle Eastern spare capacity to replace these supplies — to result in a net impact that oil prices are likely to continue to climb, potentially beyond $130The difference is not made up by relief measures, such as the Strategic Petroleum Reserve releases.

Of course, there is disagreement. Citi’s commodities team stated last week that it was becoming more likely than not that oil prices will reach a peak or consolidate at a high level. However, this would be contingent on a decline in Russia’s invasion of Ukraine as well as progress with Iran talks. Citi claims stock build is possible in 2Q22, despite the fact that U.S. inventories have fallen to or are near their lowest levels. 

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Nicholas Colas was co-founder DataTrek ResearchIt is time to consider how energy stocks can be incorporated into a portfolio.

How close it is to a recession when the oil price drops

Colas, who was an auto analyst earlier in his career remembers how economists at the Big Three automakers used presentation decks three decades back. They had been using them since the 1970s oil shocks.

According to him, the rule of thumb he learned from economics experts in the auto industry in 1990 is that when oil prices rise by 100% over a 1-year period, you can expect a recession.

Crude oil cost $63.81 per barrel in March 2021, a year ago. That’s double the price of crude oil, which is also the strike price in a recession. Crude oilIt is currently $115

Colas declared, “We are getting close”

“We are at the stage now when prices at the pumps are higher on the return journey from work than the entry way,” Bespoke wrote in a note to clientsFreitag

Colas stated that oil prices must be consistently above the doubling point, at $130 per day, rather than just spike and pull back fast to become a concern. He said, “A few days is fine but not a lot of weeks.” 

The evidence isn’t very deep, but that’s a big caveat. Colas explained that “Recessions don’t happen very often” and cited three periods from 1990.

Another market analysis suggests that oil is no longer the 1970s and makes up a smaller percentage of GDP than in 1970. JPMorgan’s last-fall analysis showed the following: equity markets would hold upEven with high oil prices, the environment is still favorable.

Gas usage, consumers demand, and the economy

However, it is clear that oil prices are driving the price of gas and that the 70% consumer market accounts for 70% of the U.S. economic activity. Colas explained that if you take so much money from someone’s pocket it will have to come out of somewhere else.

As the Covid omicron wave has fallen, the spike in gasoline and oil prices coincides with a return to normal for commuting.

Office occupancy stands at 35%-37% at the moment. The commute is becoming more difficult for many workers, as as much as 65 percent of them are currently home and need to travel in to work. Gas usage in the U.S. has been climbingIncreasing steadily to 8.7 Million barrels and rising quickly

Although the return to office is good for the economy as it supports urban growth, Colas believes that a more stable economic environment where oil prices are consistently above 100 percent per year will be detrimental to the GDP. “Can we still grow if the oil price stays at 100 percent?” The recent history shows that no.

Although there are some evidence to suggest that spikes in oil price didn’t bring down the economy during recent times, there was one key difference today and those past periods. The previous recession-inducing periods, which did not result in economic contractions, were 1987 (+85%) or 2011.

While oil prices might have risen rapidly in recent times, the levels were not that high relative to previous years. Colas stated that consumers were already aware of these prices and, while it was unwelcomed, they did not surprise them. In 1987, we saw a significant percentage increase in WTI, however it was not an absolute rise compared to the previous years. From 2011 – 2014, the percent change off the 2009 – 2010 bottom hit 80 percent, but on an absolute basis WTI was in line with the immediate pre-crisis past.”

The S&P 500 history of oil companies

This past decade was not kind to the energy industry. S&P 500Investors are overweight in stocks that contain energy stocks. At the moment, 3.8% of U.S. stock markets are in the energy sector. Although energy stocks have rebounded from the March 2020 pandemic low, their market profile has not changed. Think about the fact that Alphabet (4.2%), Microsoft (6%) or Apple (7%) all have higher weights than the entire sector of the energy industry in the U.S. stock exchange.

Farther back, energy was 29% of the S&P 500 in December 1980 after a decade of oil shocks and huge gas price spikes. That was the U.S. stock exchange’s current technology. The fundamental underweight in energy is understandable. In seven years, the sector has either been the most poorly performing or the second worst.

Nevertheless, Warren Buffett’s Berkshire HathawayRecently, the company doubled its size ChevronLast week, investment increased by around 30% revealed a $5 billion stake Occidental Petroleum.

It is possible that even if oil prices are a probable cause of a recession right now, energy stocks — represented by sector ETFs such as XLE — are still buys.

However, this doesn’t necessarily mean that energy stocks will be immune to the effects of recession. While the sector’s stocks may not be as positive as other sectors, they can still beat others. Colas explained that “all correlations go one if VIX is at fifty,” referring to market volatility which could signal a crash. He noted, however, that the equity market has not crashed despite rebounding from recent spikes of the VIX to the 30s. Current geopolitical developments and the overall supply-demand imbalance of the crude market are evidence that oil prices can be sustained. Combined with the energy sector’s diminished weight in the S&P 500, the sector’s valuation as a whole, “is just ridiculous,” Colas said.

Why you shouldn’t shorten your energy stocks 

It isn’t the 1970s and energy has lost its relative prominence. However, in 2017, market pundits talked about the oil sector as “terminally” valued. In fact, the sector still accounted for over 6%. It was a wise decision to buy the bottom in 2020 when it fell to 2%. However, Colas claims that 3.8% doesn’t mean it is time for you to sell. While I do not know the correct number, Colas says that it is close to 5%. 

For Colas, doing the math on energy stocks as still being undervalued is simple: In 2011, the energy sector weighting in the S&P 500 was almost triple its current index representation, as high as 11.3%, and when energy was at similar prices. “What more do you require?” He replied.

Investors need to be focused right now on hedge risk, not just in the U.S. stock market with energy stocks. Last week saw energy stocks in Europe suffer, which proves that the argument for U.S. oil is not just about oil prices. European equities just keep falling apart. Colas stated that we don’t have a common land mass with Russia. 

Colas concluded that investors should look at this stock market as an opportunity to win energy.

A recent update from S&P Global Market Intelligence showed energy shorts to have reached the highest level since 2020, but the details show that while there are a few big bets against “wildcat”-style drillers, these short bets are more likely to be in other energy niches, including in renewable energy spots like EV charging, as well as in the coal sector, rather than among the biggest oil and gas producers. In fact, the largest U.S. oil company had a total of 57 employees. less short interest than the S&P 500 as a whole.

Colas stated that the biggest mistake made by analysts is shorting a new peak. Colas said, “Never try to shorten a high.”

He stated that $130 was the highest price oil can go for. We don’t see much more than a 100% return. However, oil stocks can be so inexpensive and yield good dividends.”   



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