Liz Looks at: Energy
Supply’s the Limit
A curious thing happened on Tuesday. The broader equity indexes were all down, every sector in the S&P was down, volatility spiked, but the energy sector eked out a positive 0.5% return. Shouldn’t Energy, which isn’t viewed as a defensive sector, have gone down with the other cyclical sectors?
Enter our old friend “supply chain woes,” and the move makes more sense. Energy is up 45% YTD compared to the S&P’s 17%. At just a 2.5% weight though, its strength is overshadowed by larger sectors that are underperforming the index YTD, such as Technology and Consumer Discretionary.
The next question then: is the strength in energy durable or just another transitory force that will relax when the rest of the players on the transitory team relax?
I think it’s durable over the next six months. Here’s why.
Demand/Supply Tailwind Goes Global
Brent crude oil recently reached $79.53/barrel, the highest price since October 2018. Commodity prices are largely affected by the balance, or lack thereof, between supply and demand. Right now, forces on both sides are driving energy prices higher, and it’s not just in the U.S.
The initial demand shock from Covid-19 has passed, and the subsequent shock from the Delta variant passed more quickly than inventories and production could keep up with. In fact, draws on oil inventories globally have accelerated to a point that, if conditions remain the same, global inventories are on track to reach their lowest levels since 2013 by year-end.
Add to that a pickup in mobility that’s increasing demand, particularly in Asia. The recent lifting of travel restrictions has also driven air travel demand.
And it’s not just about oil; natural gas prices are soaring in Europe due to unseasonably cold weather in spring that caused a depletion of inventory. Prices are still high as we approach the winter heating season. Europe is heavily dependent on gas supply from Asia, South America, and Russia to meet its needs, so any constraints or political disruption can hamper the inflow.
Not to mention, economies around the globe are still reopening and haven’t reached steady state levels of activity and mobility. So more demand is likely to come and supply is unlikely to meet it.
Thesis Busters
In the case of commodities, particularly energy, there are forces outside our control that could completely change this thesis. I mention them because they’re important to watch for over the next few months as reasons to reconsider your allocation (I’ll be doing the same).
One of those possibilities is a sudden weakening in demand due to another flare up of Covid that results in renewed travel restrictions and limited mobility. Given how quickly we seemed to bounce back from the Delta variant, this is not a possibility that greatly concerns me. Though, it’s worth noting that flu season, just around the corner, could be a wild card.
Another possibility is a sudden increase in supply and buildup of inventories. That would require OPEC+ to ramp up production enough to offset growing demand. This is a force far out of our control and one that’s always ripe for surprises. However, with prices as high as they are, there’s not much incentive to flood the market with more supply and push prices down to a less profitable level.
Although these things could happen, I’m putting them both in the “possible, not probable” category for the next few months.
Up One Side, Down the Other
In this case, what might be good for stocks is unfortunately bad for our wallets. Even though we remove food and energy from many inflation measures, we as consumers purchase food and energy on a daily basis. So although the supply/demand imbalance in energy has fueled (see what I did there?) stock and commodity prices, it’s also going to weigh on our spending. The interesting part about energy is it’s one of the spots where you can at least attempt to offset your increases in cost with the potential return on your investment. In other words, to make more than you spend. Isn’t that the goal, after all?
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Communication of SoFi Wealth LLC an SEC Registered Investment Adviser. Information about SoFi Wealth’s advisory operations, services, and fees is set forth in SoFi Wealth’s current Form ADV Part 2 (Brochure), a copy of which is available upon request and at www.adviserinfo.sec.gov. Liz Young is a Registered Representative of SoFi Securities and Investment Advisor Representative of SoFi Wealth. Her ADV 2B is available at www.sofi.com/legal/adv.
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