The XLE, the exchange traded fund (ETF) for energy companies has declined 40% this year-to-date. The shares of Exxon Mobil and Chevron are down similar amounts. The NASDAQ 100, NDX, has risen 23% year-to-date led by Microsoft, Facebook, Amazon, and Alphabet. These four stocks now make up almost 20% of the Standard & Poor's 500. All of technology now represents more than 40% of the index. Energy now is an inconsequential 2%.
This relative performance differential plays throughout the markets. The Russell 1000 Growth Index which is dominated by the tech stocks has gained 16% year-to-date. The Value index which includes big oil, big banks, etc. has declined 16%. Covid has played a significant role in this performance.
In the short run, wholesale lock downs of economies worldwide have obviously decreased the demand for oil and natural gas and called into question how bad bank loan losses might be. It is not surprising with WTI oil down from $56 to $40/bbl and natural gas prices down from $2.27 to $1.80/mcf that the energy stocks are down. It is also no surprise that in a deep lock down induced recession, banks are increasing loan loss reserves substantially and their stocks are down.
At the same time, the lockdowns are having the result of increasing demand for data, delivery, games, and anything you can do at home. The big four tech stocks reported earnings this week and blew well past expectations. It is no surprise that in this short time these stocks have done extremely well.
There are also some longer-term trends at work. The worldwide demand for oil and gas has been declining relative to GDP for several years at a slow pace. It is still growing in emerging markets and China but declining in the developed world. The Covid crisis has accelerated that trend. Airlines in the US use lots of fuel. Their flights are down some 80%. People stay home and drive less. The rapid drop in demand and consequent price drops for oil and natural gas are giving big oil a preview of the future, today.
On the positive side, the digitization of everything was well established and growing before Covid. The lock downs accelerated this trend. Prior to Covid, online purchases were about 13% of retail sales. Today they are 17% and growing fast. The demand for data is growing exponentially. The markets are not irrational. Maybe it is not ridiculous that Amazon sells at a price/earnings ratio of 150X. In all markets there are winners and losers.
All of this seems obvious in retrospect. But I would like to take the side of the losers, energy companies, for a minute.
The Covid recession has hit big oil like a 2x4 to the head! It is forcing these companies to deal with an unpleasant future, and deal with it now. There is no question that all the big oil companies are giant bureaucracies that are rightly slow to respond to short term trends. But climate change politics is a long-term issue. And short-term problems caused by the Covid crisis are giving managements the excuse/opportunity to right size these companies.
Chevron has said they are reducing headcount companywide by 15%. They are cutting 25% out of exploration. They can buy all the oil they want in the stock market a lot cheaper than looking for it, as they just did with Noble Energy. Exxon Mobil has announced a companywide review of operations which will likely result in similar layoffs. Royal Dutch, BP, etc. are as well. Schlumberger is laying off 21,000 people. This will be hard on the people effected, of course. Houston and Texas will certainly feel it. Covid has forced the issue.
But, make no mistake, the world is still hooked on oil and natural gas. These companies are run by smart people. They will come out of this leaner and more correctly suited for the longer run future. In the short run, the solution to low oil prices is low oil prices.
Drilling has stopped. Lending to fracking companies has stopped. Supply will be constrained. When the world recovery from the virus gets going, demand will increase. Prices will rise. It may have already begun with the recovery in China.
Exxon Mobil and Chevron have said they have every intention of maintaining their dividends. XOM yields 8.5% today. CVX yields 6.2%. Most investors hate these stocks, and for good reasons. But those reasons are changing. I would expect oil prices to be higher in twelve months. The big oil stocks should be higher reflecting higher commodity prices and the leverage from their downsizing.
A note from WSC and WAMI . . .
Robert C. Davis is a Chartered Financial Analyst and is affiliated with Woodlands Asset Management, Inc. as a consultant. Founding partner of Davis Hamilton Jackson and Associates, a Houston based investment advisory firm; Bob is now retired and living in Chappell Hill, Texas. He now lends his expertise and knowledge of the markets to our company and customers. We hope you find it interesting and insightful.
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