How Much Should We Fear the Energy Woes?

Historically, crude oil sell-offs do not lead to long-term broad-market ugliness

Dec 9, 2015 at 9:35 AM
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The markets are a little jittery this week, but fortunately we have a designated worry to guide us. Yes, this week's sell-off is brought to you by very weak oil. Texas tea. Crude oil, that is.

The bad news is crude itself is a falling knife. Well, bad news for the markets, apparently. It's not the worst news if you're doing something like filling up your tank on the way to the mall.

The good news? It doesn't appear to lead to much in the way of long-term market ugliness. It doesn't lead to much strength, either, but that's for another day, perhaps.

The Energy Select Sector SPDR ETF (XLE) is a select spider that indexes S&P 500 Index (SPX) stocks that are in the energy sector. Here's a look at XLE vs. the SPDR S&P 500 ETF Trust (SPY) back to the creation of XLE in 1998:

151209agw1

The ratio right now is about 0.30 vs. the long-term average of 0.40. And clearly it's in a major downtrend. It hasn't been this low, in fact, in a decade. But another way of looking at it is energy stocks had a pretty large relative rally from 2005, and we're simply reverting a bit.

More importantly, though, it doesn't portend much going forward. The correlation of the XLE/SPY ratio to one-month forward returns in SPY is 0.01:

151209agw2

It's basically a trendless blob. Some of this is self-reinforcing, as XLE makes up a varying, but always significant portion, of SPY. And in other eras, it was likely less about energy and more about other sectors. In the late '90s, e.g., it was more about the larger relative valuation on tech than anything energy-related.

This is hardly the only time energy has taken center stage, though. And we do have a rather large slice of time to analyze, which includes all of the above. And there's no particular indication energy sector woes will drag us into much of anything scary.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.


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