If you read yesterday's Market Musings, you will be aware that I expect the start of next year to be a slow one at best for stocks. That doesn’t mean, however, that investors shouldn’t be thinking right now about establishing a few positions that stand to benefit over the course of the year. In most sectors it will probably pay to wait as big picture factors hold back stock prices in general, but there are two areas where, for very different reasons, delay may result in missed opportunity...energy and biotech. Over the next couple of days I will look at both, starting today with energy.
I know that there have been a whole host of false starts when it comes to energy. I have had as many as anybody, but, as I have pointed out many times in the past, if you bottom fish with discipline and set stop loss levels quite tight you can be wrong several times about the exact timing but still make a good profit overall when an under pressure sector or stock does turn around.
Obviously the future for energy stocks is dependent on the price of oil, and there are signs emerging that this time in that regard we may actually have found a bottom, at least for now, in the mid $30s. The more we touch and bounce off of those levels, the stronger the support becomes.
The collapse in WTI has stopped for a number of technical reasons such as that, but fundamentals have yet to turn. Removing the ban on U.S. oil exports has resulted in the spread between Brent and WTI disappearing which has helped somewhat, but oversupply is a global problem, and exporting more American oil doesn’t solve it. As always, though, there are two ways to look at the supply/demand situation.
The bear case for oil prices depends on the belief that the Saudis, presumably as part of their strategy against ISIS, actually want lower prices and will continue to increase production to achieve that. In addition, the bears believe that global demand will actually fall as much as has been feared, if not more.
The bulls, on the other hand, see potential problems for the Saudis if prices continue to drop, and see added pressure within OPEC from other countries which are suffering. On the demand side of the equation, they view the divergence of central bank policies as a driver of renewed growth outside the U.S. as monetary stimulus continues in Asia and Europe.
The most likely scenario, as is so often the case, is somewhere in the middle. If OPEC is to survive intact, the Saudis can only push so far; some concessions to other members will have to be made. That could come in the form of a few hints at cuts rather than actual reductions in production, but some form of price support would come as no surprise. On the demand side there are still problems, but relief is in sight. The strong dollar may be hurting U.S. companies with an international presence, but it is a boon for exporters from other countries. The stimulative effects of that scenario should begin to show at some point.
The bull and bear case each have merit and could, to some extent, both be correct. That would, in normal circumstances, create a kind of equlibrium; leaving oil prices steady, but these are not normal circumstances. The dramatic and sustained drop over the last year and a half has made oil more vulnerable to an upward move than further declines. Speculative longs will have been squeezed out by now and there will be plenty of shorts. Absent other factors, or if those factors balance out as I expect, the default move for oil will be upwards.
None of this points to a dramatic recovery for WTI in the first quarter, but if we really have found a base then the risk is to the upside. That makes establishing a long term position in something like the SPDR Energy Sector ETF (XLE) now, or at least beginning the process of dollar cost averaging into one a smart thing to do, even if you feel that stocks as a whole face an uphill start to the year. The same can be said in some ways for the biotech sector, but for very different reasons. Tomorrow I will explain what those reasons are.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.