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The safe-haven this year hasn’t been bonds (they’ve been killed), or gold (it's down double-digits since March), and it certainly hasn’t been Bitcoin (despite all those pre-bear assurances). Nope. It’s late-cycle commodities, specifically energy stocks, that have offered investors safe harbor.

The Energy Select SPDR ETF  (XLE)  has returned a show-stopping 55% this year, a somewhat remarkable 76% better than the S&P 500 ETF  (SPY) . Of course, there’s a good reason why it’s been heady times for the group. Commodity profits have soared because of easy-money fueled demand, stubbornly stuck oil well spigots and the War in Ukraine. Mix that with the fact that the energy complex was significantly under-owned by investors big and small, and you’ve got a perfect recipe for upside.

However, that was then and this is now. 

Skyhigh crude and natural gas prices are a hallmark of the late stage of the business cycle. Energy stocks' performance during a recession is uninspired, with a negative average and median return and a neutral “win” rate. And they lag in the early cycle when post-recessionary excitement shifts to technology, discretionary, and financial stocks.

Is the run in energy stocks about over?

This is far from the first time that crude oil prices have risen significantly into the teeth of a bear market. For example, West Texas Crude prices rallied to $147 per barrel from below $50 per barrel between January 2007 and July 2008 even as the S&P 500 fell by double-digits.

In “Oil Can Only Go Up? Yeah, Right, Where Have We Heard That Before?”, Real Money's Maleeha Bengali writes, “as we know, commodities are all about timing, especially when the floor underneath them across a host of asset classes is collapsing. The current scenario is awfully similar to 2008, for those who are veterans to have lived through it, not just read about it. Then, it too held up for three months defying the housing collapse, Bear Sterns collapse, only to collapse.”

And collapse it did. After peaking at $147, crude oil prices fell for seven consecutive months before finding footing at about $32. For those without a calculator handy, that’s a 78% bludgeoning.

Of course, some argue that $147 then is actually much higher today. If you adjust it for inflation from 2008 dollars to today, it works out to a peak of nearly $200. On its surface, that might lead some to believe that there’s still plenty of room to climb given that WTI is about $122 today.

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But prices don’t work that way. There’s no rule saying that stocks must trade back to a prior peak. In fact, price anchoring is one of the biggest and most common mistakes investors make. Sure, oil could eventually go to $200, but there’s no rule guaranteeing that happens.

Back to Bengali

“[A comparison to 2008] is not an apples-to-apples comparison, as inflation back then was not averaging more than 8% year-over-year and the consumer disposable income was a lot healthier. Today, the average consumer cannot buy gas, gasoline, or a house, or pay its doubled mortgage rate, nor even see a higher wage growth. How is the U.S. economy to grow?... The problem with the markets has been that the Fed has saved them each time since 2008. But today they do not have $30 trillion-plus in debt and 8% year-over-year inflation showing no signs of falling yet. They cannot just print more money to stem the market decline as that would cement hyper stagflation for life.”

Bengali has a point. In the past, the Federal Reserve had wiggle room to ease the economy back to growth. Today, its balance sheet is bursting and it’s knee-deep destroying demand with Fed rate hikes and quantitative tightening (reducing its balance sheet by choosing not to replace maturing bonds on its balance sheet). That’s not a recipe for increasing oil and natural gas demand and supporting prices. Consumers are rationing at the pump, increasing credit card balances, and repurposing Dollars aimed at discretionary purchases for necessities, like food. Again, not a bullish scenario for demand.

Back to Bengali:

“The other problem, which is very common in commodity circuits is to overestimate demand. At times of high prices, demand is assumed to hold up and they only focus on supply. But it never works that way. It is all connected and we know demand is going to fall as every single measure of Institute of Supply Management, PMI, and macro economy data is suggesting. When that happens, prices will fall. It is a matter of when not if.”

The Smart Play

When markets sell off and margin lenders come knocking, investors scramble to raise cash to avoid forced liquidation. 

Often, the best move is to sell the losing investment that caused the margin call, but human nature usually means folks sell their last winner standing (ego protection). In this case, that's energy stocks. Yesterday, we may have seen some of that happening. The SPDR Energy Select ETF dropped over 5%, which was more than the 3.9% tumble in the S&P 500.

Having said that, energy stocks are still technically intact. While the S&P 500 closed near its low of the day, the XLE bounced near support at the 50-day moving average on Monday before recouping some of its losses into the bell. So, investors might not want to press the sell button just yet. 

After all, the drivers behind higher prices remain. The War in Ukraine is still being waged, crimping global supply, and OPEC remains reticent to increase production (it controls 80% of the world’s proven oil reserves). Furthermore, twice-shy U.S. suppliers that nearly avoided bankruptcy when oil prices went negative in 2020 have yet to unleash budgets to ramp supply (although, producers are tilting toward the greed necessary for that to happen).

Energy stocks could still be worth buying, especially if it takes longer than hoped for the Fed’s rate cuts to tame inflation. 

I suspect a big increase to the Fed Funds rate tomorrow (0.75%) may increase volatility in energy stocks as more people begin to debate the peak oil price argument, and if so, that could allow some entries into top stocks. 

The big beneficiaries at this stage of the move in energy prices could be midstream players who get paid based on production flowing through pipelines and facilities, and energy services stocks, who benefit from pricing power as more producers reinvest in production. 

Outside of those plays, exploration and production plays in the low-cost Permian basin remain worth a look too. Their break-even prices can be as low as in the $30 to $40 per barrel range, so they’re likely to kick off plenty of profit that can be paid out to shareholders in dividends or via buybacks for a while.

Nevertheless, you should treat energy stocks like rentals. Don’t fall in love with them and don’t use margin to buy them.

If the XLE closes below its 50-day moving average, make sure you're using trailing stop losses to protect your portfolio. You don’t want to turn a winner into a loser. Remember, energy stocks are called “cyclicals” for a reason.

At some point, the music will stop, and you won’t want to be without a chair when it happens. As Bengali writes, “Newton had it right, what goes up must come down. Shame everyone is holding onto the "One" asset as they feel oil is running out. After all, we are told it is the safest place to be and can only go up. When have we heard that before?”

The safe-haven this year hasn’t been bonds (they’ve been killed), or gold (it's down double-digits since March), and it certainly hasn’t been Bitcoin (despite all those pre-bear assurances). Nope. It’s late-cycle commodities, specifically energy stocks, that have offered investors safe harbor.

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