Please ensure Javascript is enabled for purposes of website accessibility

Why Oil Stocks May Be Headed for Another Pullback

Oil stocks have rebounded nicely this year on the heels of recovering oil prices. But is the long-term downtrend in oil truly over? Recent red flags suggest not.

Eight months ago, in mid-December, I made a few predictions for 2016. But I cheated slightly—instead of predicting things I thought were going to happen, I just identified trends already in progress, and based on the fact that stock market trends tend to continue, I “predicted” that 2016 would see similar conditions. My first prediction? “Oil Prices Will Stay Low.”

Here’s what I wrote, copied verbatim:

For a while, I was right. Not only did oil prices stay low, they continued falling for about two months after I wrote that—as did oil stocks. In January, Morgan Stanley said they could see a scenario in which oil fell as low as $20 a barrel, while the brains at Goldman Sachs theorized that sub-$20 oil was possible.

Of course, practically as soon as those reports were published, oil’s slide tapered off, finally coming to an end in mid-February. At over 70% off their 2014 high, oil prices started to rebound soon after. Investors began piling back into oil stocks, and despite their rocky start, energy stocks soon became the second-best-performing sector year-to-date.

In May, Goldman forecast we’d be back to $50/barrel oil by the end of 2016, and in June Morgan Stanley pushed their oil price target back to $80 per barrel. It started looking like my December prediction that oil’s slump would continue may have been too pessimistic after all.

Fast forward to today, and here’s what a one-year chart of the United States Oil Fund (USO), an oil ETF, looks like:

After a four-month rebound, oil prices rolled over again in mid-June, just when the “summer driving season” was supposed to bring demand more in line with supply. Instead, increasing production led to growing stockpiles, and now alarm bells are ringing again. Oil prices are back where they were in April, and headlines like this one (from Monday) are common once again:

So what do I expect oil stocks to do now?

On the one hand, the trend remains down, clearly:

And as I wrote when I “predicted” more low oil prices in December, “trends tend to last longer, and go further, than anyone expects.” To quote, again:

That single fact—not rig counts or consumer sentiment or the political situation in Libya—was the basis for my “prediction” last December that oil prices would stay low this year. (It was also the basis for predictions two, three and four, which you can read here if you’re interested. So far none of them are wrong.)

On the other hand, another of my father’s favorite investing guidelines is, “When everyone thinks alike, everyone is likely to be wrong.”

Today, everyone else expects oil prices to decline further. Just look at the headline above from Bloomberg. Or look at the fact that institutional investors—who made energy stocks the second-best performing sector of 2016 to date—have done a 180-degree turn on oil prices in recent weeks. Last week saw the largest increase in short positions against the price of West Texas intermediate crude since at least 2006.

And yesterday, this headline greeted me on CNN’s website:

Exxon Mobil (XOM) stock was 30% off its 2014 highs north of 100 before the rally in oil stocks began. But after a few months of improving oil prices, XOM had made up nearly all of those gains. In June, Morgan Stanley upped their price target for XOM to $95, and the stock hit that target one month later.

Today, Exxon Mobil stock is back below 90, and headlines like the one above have replaced analyst upgrades.

So are we at an inflection point in sentiment, when investors have become as negative as possible and there’s nowhere for prices to go but up?

Or are we in the middle of a long-term downtrend in oil (and oil stocks), which will continue far longer than anyone expects?

Only time will tell, but, given that most of today’s oil bears were oil bulls only six weeks ago, I think I’ll stick with my original “prediction” for now: “Oil Prices Will Stay Low.”


Chloe Lutts Jensen

P.S. No Better Time to Join then Now

Today is a fantastic time to be a dividend investor, but it’s also a complicated time. As we’ve seen this year, even “widow and orphan” stocks aren’t what they used to be! But Cabot Dividend Investor and my Individualized Retirement Income System (IRIS for short) can still make income investing both simple and profitable.

Just click here to learn more.

Chloe Lutts Jensen is the third generation of the Lutts family to join the family business. Prior to joining Cabot, Chloe worked as a financial reporter covering fixed income markets at Debtwire, a division of the Financial Times, and at Institutional Investor. At Cabot, she is a contributor to Cabot Wealth Daily.