It Is Universal Pessimism, Not Reality, That Is Pummeling Oil Stocks

 | Jun 12, 2017 | 11:00 AM EDT
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In my early days of trading, I listened carefully to the old guys on the floor. They had lots of sayings that just turned out to be true. "Don't fight the tape," and "The trend is your friend," were two you probably know yourself. One of the ones I heard from my mentor was on the psychology of the market. It went something like this: 

"In a bullish market, all news is bullish. In a bearish market, the same news will drive the market lower."

It sounds ridiculous, but this past week proved just how on the money that saying continues to be. 

Last week, saw incredibly pessimistic reactions in the oil markets to what should have been very bullish news. We've seen those bullish fundamentals somehow rewritten as bearish indicators -- and watched as oil and oil stocks have sunk lower.

For example, OPEC and Russia came to a historic alliance to control supply for the next nine months, yet the reaction was muffled. "Couldn't they have done more?" many analysts mumbled, and instead of rallying, the oil markets dropped. 

Trump's unpopular decision to pull out of the Paris Climate agreement would at least have a positive impact on energy prices, right? Not the way it turned out. Analysts worried that oil companies could be hurt by the revitalization of coal -- and markets continued lower.

In the previous two weeks, we saw two massive, unexpected drops in U.S. oil stockpiles, both of which led not to a gain in oil prices, but a small loss. Alternatively, last Thursday's unexpected build in stockpiles was met with a complete rout of oil and oil stocks. 

In the first quarter of the year, Morgan Stanley's and Goldman Sachs' bearish fear for oil was that global supply and demand wouldn't rebalance in 2017. And while they have convinced themselves that oil will in fact see a balancing this year, they now both are afraid that U.S. shale production will increase another 1 million barrels a day in 2018, leading to a resurgent glut just as the OPEC production deal is rolling off.

It doesn't matter whether much of what's happening in the oil markets since the OPEC/Russia oil deal is all about perceptions -- and misperceptions. When markets are frightened, and the participants are all thinking the same way, you cannot fight the force.

That universal pessimism has pummeled and punished oil investors.

Of course, fundamentals always win in the end. But another piece of old wisdom I learned early on applies here: "Markets can be irrational longer than you can remain solvent."

Here's a recent history lesson that's a perfect mirror image of what's happening today: Throughout 2013 and 2014, the oil market sustained an oversupply of more than a million barrels a day. For nearly two years, as oil hovered at or above $100 a barrel, analysts then trotted out convoluted explanations describing this glut as perfectly normal and even bullish for prices. 

Ultimately, we saw these fundamentals exert themselves as oil dropped from over $100 a barrel to under $30.

Let's look at the fundamentals today: Is the oil supply contracting? Yes. Is global production rolling over -- and here in the U.S. in two of three major U.S. shale plays? Check. Has the OPEC deal to remove 1.6 million barrels a day held with unprecedented compliance? Yep. Are capex budgets still in collapse, making replacement of spent wells expensive, if not impossible? Check, check and check. 

All of this should ultimately lead to a wildly bullish move in oil. But just as in 2013, we can't just buy stocks randomly and hope that the markets become less irrational on our own schedule.

At this point we need to respect the pessimism, sit back and wait for the inevitable turnaround. We can always get aggressive on the way up.

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