Energy stocks to provide a safe haven when the tech bubble bursts

The failure of energy stocks to respond positively to the ongoing rally in crude oil prices is reminiscent of the later stages of the 1999 tech bubble. The potential for accidents in a technological sector is becoming much more likely, and as we saw in the early 2000s the energy sector can act as a relative safe-haven in the coming months and years.

Energy sector rally continues under radar

Crude oil prices have continued their strong recovery since April with Brent, which is set to move above its 200-day moving average in line with the trends seen in the WTI. Despite strong gains, the rally in crude oil has gone somewhat under the radar in recent months, gaining muted media attention or speculative investor sentiment.

Oil prices remain deeply depressed from a historical perspective, yet for the first time in 1990, the US money supply at this level is trading near levels despite a six-fold increase. Regular readers will be aware of our view that inflationary pressures will increase in the coming months and years, and oil prices rise accordingly. As reported by HFI Research in mid-August, a parabolic move in oil prices is likely because it would charge too high prices to stimulate improvements in US shale production.

Ideal setup for better performance in energy sector

Energy sector stocks have historically outperformed during the oil price period for obvious reasons but over the past few months XL has dramatically reduced SPX. As the chart below shows, the rolling correlation between the XLE / SPX ratio and the WTI is the most negative on record as investors ignore the positive impact of improving oil prices on energy sector earnings.

MSCI US vs WTI Crude Oil Share of Energy Sector

Source: Bloomberg, Author Count

Based on the historical correlation between SPX’s energy sector share and real (inflation-adjusted) WTI prices, the recent crude rally suggests that SPX’s energy sector share should be nearly three times higher than current levels.

Source: Bloomberg, Author Count

Investors may dismiss the recovery in oil prices as a major contributory factor in driving the energy sector, as many headwanders facing the sector as environmental regulation and ongoing shift in investor focus for sustainability . However, income in the region is almost entirely driven by crude oil prices. As the chart below shows, real oil prices boost the energy sector’s net profit by nearly nine months, and a recent WTI rally points to a strong recovery in earnings in the coming quarters.

Source: Bloomberg, Author Count

The underperformance of the energy sector mainly reflects the tech bubble

While we believe that the US energy sector is fairly valuable in itself, its relatively poor performance relative to oil prices and the broader market reflects large-scale growth and an increase in technology shares. Outperformance is reminiscent of the late 1999 / early 2000s when energy stocks traded despite a strong oil price rally as investors shook the sector in favor of technology stocks.

The way the speculative craze of the 1990s ended gives us some comfort that we should see another Tech Crash Energy stock, as they did then. There are two main reasons to be optimistic that the energy sector will perform well even in the midst of a slowdown in a technical sector. First, the rally in tech stocks has not been driven by strong real GDP growth, so we would not say that the tech sector is expected to reduce growth. Second, inflationary pressures persist due to the continuing fall in the dollar and rising inflation expectations, and we expect resource stocks to benefit at the expense of the broader market.

Disclosure: I / We are long XLE. I wrote this article myself, and it expresses my own opinion. I am not getting compensation for this (other than Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.