Chart(s) of the Day: Crude Oil s Secular Story Dan Wantrobski CMT (215) 665-4446 Research Analyst Certification and Important Disclosures start at the bottom of this document Historical charts of crude oil prices show similar secular characteristics to U.S. equities in our view. The two markets typically exhibit a longer-term negative correlation to one another, though they have certainly shown themselves to be positively aligned for significant stretches of time ( cyclical trends) throughout their history. This suggests to us that the recent decline in crude prices supports our macro call for a secular bull in U.S. equities, as energy prices (and the broader commodities markets in general) continue to underperform stocks on a relative basis in the years ahead.
In the chart above, we plot annual crude prices (U.S. dollars) back to 1900. We have marked off the major turn dates in the commodity s longer-term trend, as well as a few notable events surrounding these inflection points. Typically, a secular trend in oil prices has shown itself to last anywhere from 10-15 years on average- this duration is very similar to that of a typical equity market cycle and this is one of the key relationships that drives our long-cycle model. When we overlay this chart with data from the U.S. equity markets, we can see the inter-market relationship more clearly:
In the chart above we plot crude oil prices against the U.S. stock markets (orange) back to 1900. The immediate takeaway is that on a very long-term basis, the two have a distinct upward bias and appear very strongly (positively ) correlated to one another. However, upon closer inspection we find there to be a hidden cycle at work underneath the surface. That is, once we parse out the major equity cycles (based on price and valuation cycles), we see a much different interaction between the two- where a loose negative correlation exists as the asset classes compete for investment dollars: 1910-1920: equities range bound (bear cycle) against a dramatic rise in crude oil prices, which peaked at the beginning of the Roaring Twenties (1920). Oil prices rallied a whopping +380% during this period. 1920-1929: the Roaring Twenties energy prices decline significantly (-63%) against a secular bull market in U.S. stocks (culminating both equity and debt bubbles within the 1929-1933 timeframe).
1929-1942: the Great Depression oil prices bottom in 1931- a year before stocks hit their lows. From there, oil prices rally +57% into 1941 as equities carve out a huge trading range that barely generates a positive return (1932-1941). 1942-1966: reflationary period this is the analog we typically use to sketch out a blueprint for our current position within the long-cycle. During this period, oil prices and U.S. stocks rally together into the late 1940s before energy prices top off and then trade sideways for the next several years. In this regard we view the most recent reflation off the 2009 bottom in similar fashion (both stocks and energy prices initially rallying together, before commodity prices start to trail off in 2011). 1966-1982: stagflationary cycle here in the U.S energy prices spike dramatically (oil embargo of 1973) against a structural bear market in stocks. 1982-2000: deflationary bull market cycle oil prices peak around 1982- the same time valuations on U.S. stocks hit bottom at 7-8Xs. Equities stage a massive secular bull market against declining energy prices into the peak ( Tech Bubble ) of year 2000. 2000-2009/11: deflationary bear market cycle oil prices trade from $9-10 a barrel up to $120 while stock markets experience a structural bear market (Tech Bubble & Financial Crisis) against declining interest rates. 2011-2011/12: new cycle emerging which we believe will be looked upon as an reflationary bull cycle for the U.S. Oil prices produce a peak in 2011 after reflating along with equities off the secular bottom in 2009 2011-2012 marks the transition period where equities continue their secular climb higher (driven off price action, valuation, demographic & credit cycle trends ) while commodities revert back toward a structural bear cycle. This drives the ongoing negative correlation between the two, as stocks outperform commodities in general on a relative basis. Again, the average duration for these cycles has shown itself to be roughly 10-15 years. As an aside, if instead we chart oil prices against the valuation cycle in equities (Schiller CAPE driven off the S&P 500 or proxy), we see a much stronger relationship (negative correlation) because nominal price noise is negated. Put simply, when stocks are cheap they are more attractive than commodities as an investment class (in this case oil)- and of course, vice versa:
In the chart above, we plot the market multiple (orange) against crude oil prices dating back to 1900. Here we can see a distinct negative correlation throughout their history together- as cheap valuations tend to align with peak oil prices, and expensive stock markets align with commodity price troughs. In this regard, we can see that beginning around the 2009-2011 timeframe, another transition has been taking place- where a new cycle in multiple expansion counteracts what could very well be a secular top in energy / commodity prices. Bottom Line: Clearly on a short-term basis oil prices are now very oversold. But regardless of where they bottom out in the days, weeks, or even months ahead- we believe the bigger story lies in the secular transition taking place in the financial markets. That is to say (once again) that we believe the financial markets are transitioning from the prior deflationary bear cycle (in which commodities outperformed equities on a relative basis) toward the next inflationary / reflationary growth cycle (which will favor stocks over commodities / energy on a relative basis). Thus, while we feel there will be numerous trading opportunities within the energy and broader commodities groups going forward, our bias clearly remains with overweighting U.S. stocks on a longer-term basis based on their historical correlation.
Follow Janney Technical Strategy on Twitter @Wantrobski_JMS Connect with me: Dan Wantrobski, CMT Janney Montgomery Scott LLC Managing Director Technical Research 1801 Market Street Philadelphia PA 19103 O: 215.665.4446 M: 215.495.3738 Technical opinions expressed in this report are not dependent upon the opinion of the fundamental analyst covering any security. Accordingly, the Technical opinions contained herein may differ from those of the fundamental analysts. Copies of the Fundamental Analysis reports are available upon request. All charts courtesy of Bloomberg. ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES Research Analyst Certification I, Dan Wantrobski, the Primarily Responsible Analyst for this research report, hereby certify that all of the views expressed in this research report accurately reflect my personal views about any and all of the subject securities or issuers. No part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views I expressed in this research report. Janney Montgomery Scott LLC ( JMS ) Equity Research Disclosure Legend 1. JMS is a market maker in the securities of the company and may at any time hold a long or short position in this security. 2. The research analyst primarily responsible for preparing this research report or a member of the research analyst s household has a financial interest in the securities of the company in the form of a long position in such securities. 3. The research analyst primarily responsible for preparing this research report or a member of the research analyst s household has a financial interest in the securities of the company in the form of options (O), warrants (W), futures (F), and/or a short position (S). 4. JMS or an affiliate managed or co-managed a public offering of securities for the company in the past 12 months. 5. JMS or an affiliate received compensation for investment banking services from the company in the past 12 months. 6. JMS or an affiliate received compensation for products or services other than investment banking services from the company in the past 12 months. 7. JMS may seek compensation for investment banking services from the subject company (ies) in the next 3 months. 8. The research analyst is compensated based on, in part, JMS s profitability, which includes its investment banking revenues. 9. JMS or an affiliate beneficially owns 1% or more of any class of common equity securities of the company. 10. An Employee or Director of JMS is an officer or Director of subject company. 11. Other:
Janney Montgomery Scott Ratings Distribution as of 9/30/14 IB Serv./Past 12 Mos. Rating Count Percent Count Percent BUY [B] 169 52.81 24 14.20 NEUTRAL [N] 150 46.88 18 12.00 SELL [S] 1 0.31 0 0.00 *As a percent of total coverage. Definition of Ratings BUY: Janney expects that the subject company will appreciate in value. Additionally, we expect that the subject company will outperform comparable companies within its sector. NEUTRAL: Janney believes that the subject company is fairly valued and will perform in line with comparable companies within its sector. Investors may add to current positions on short-term weakness and sell on strength as the valuations or fundamentals become more or less attractive. SELL: Janney expects that the subject company will likely decline in value and will underperform comparable companies within its sector. Other Disclosures Investment opinions are based on each stock s 6-12 month return potential. Our ratings are not based on formal price targets, however our analysts will discuss fair value and/or target price ranges in research reports. Decisions to buy or sell a stock should be based on the investor s investment objectives and risk tolerance and should not rely solely on the rating. Investors should read carefully the entire research report, which provides a more complete discussion of the analyst s views. This research report is provided for informational purposes only and shall in no event be construed as an offer to sell or a solicitation of an offer to buy any securities. The information described herein is taken from sources which we believe to be reliable, but the accuracy and completeness of such information is not guaranteed by us. The opinions expressed herein may be given only such weight as opinions warrant. This Firm, its officers, directors, employees, or members of their families may have positions in the securities mentioned and may make purchases or sales of such securities from time to time in the open market or otherwise and may sell to or buy from customers such securities on a principal basis. Supporting information related to the recommendation, if any, made in the research report is available upon request.