Wednesday, March 9, 2022
The obvious place to start when thinking about investment implications of the war in Ukraine is energy. Russia is the third largest oil producer globally (12% of total) and the second biggest global exporter of crude after Saudi Arabia (about 11%, as shown in the LPL Research Chart of the Day). Roughly one-third of European natural gas consumption and more than 25% of its crude imports are sourced from Russia. Significant disruptions to those energy exports are a really big deal.
Oil’s roughly 70% rally year to date to over $120 per barrel, which clearly reflects market participants factoring in major disruption to those Russian energy exports, has powered very strong year-to-date gains for energy stocks. We’ve started to see some of that disruption already with the United States ban on Russian oil imports announced yesterday. The United Kingdom is following suit.
“Energy could continue to be a solid hedge against oil and gas supply disruptions in Europe in the short term,” according to LPL Financial Equity Strategist Jeffrey Buchbinder, “Fundamentals look good at the moment but it’s not a “set it and forget it” type of investment.”
High oil prices from solid reopening-driven demand and tight supply, along with producers’ improved capital discipline should help support energy stocks in the near term. But there is a lot uncertainty beyond the very short term. We don’t know how much Russian energy will be taken off the market and for how long. We don’t know how much of the gap the U.S. and OPEC can fill and how quickly. These are big questions for an overbought oil commodity from a technical perspective with very optimistic sentiment based on the lack of short interest in crude oil futures and the oil futures crowd sentiment poll by Ned Davis Research.
Prior to the Russian invasion we had maintained a positive bias toward the energy sector as the stocks and oil prices broke out from a technical analysis perspective. With inflation at 40-year highs, the economy reopening, and interest rates rising, the environment had appeared favorable for cyclical value stocks even before the massive geopolitical premium was priced into oil.
All of this suggests a market weight or even a slightly positive near-term bias toward energy is probably fine but we would urge caution (the sector only makes up 4% of the S&P 500 Index). A significant geopolitical risk premium is built into the price of crude right now (probably more than $30) that could come out quickly and from a technical perspective the sector looks significantly stretched and poised for a pullback.
We continue to pray for the safety of the Ukrainian people and peaceful resolution to the conflict.
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