By David Nelson, CFA
After a stunning near 60% rally in crude, end of first quarter data suggests mutual funds decided it’s time to overweight oil stocks. That alone should make any oil bull nervous. It’s not just technology and FANG stocks where momentum traders live. Apparently they are alive and well in the oil patch.
Price momentum is a wonderful tool that works great right up until the time it doesn’t. Better to combine technical analysis with fundamentals to get a more in-depth picture of your favorite stock or sector.
Fundamentals turned for the refiners 8 months ago just as oil started lifting off the canvas rocked by a massive multi-year glut. Estimate revisions are a powerful data point often acting as a leading indicator for stocks.
Estimate Revisions Valero (VLO)
Friday’s gap down in crude and again on Monday is the hot money leaving party. Traders were quick to pick up on a potential deal between Saudi Arabia and Russia to increase output. Riyadh and the Kremlin have been effective partners forging a deal 18 months ago to cut output and currently have enough spare capacity to prevent prices from running away to the upside.
Saudi Crown Prince Mohamed bin Salman & Russian President Vladimir Putin
While Russia is not a member of OPEC it appears Saudi Arabia is looking for the next best thing. With Venezuela close to collapse and new sanctions placed on Iran, the other members seem to have little ability to control their output and as such Saudi Arabia needs a new partner.
The Saudi oil minister has hinted of concern that higher oil prices would slow global economic activity. Despite the fear in the market place, Goldman’s Damien Courvalen puts current inventories below the 5 year average.
One look at the OPEC data below shows who has the spare capacity. With other OPEC members maybe unable to increase output, the partnership with Russia makes perfect sense. The next OPEC meeting is set for June 22nd, but maybe more important is any new action from Saudi Arabia and Russia.
OPEC Production & Spare Capacity
While near term weakness is expected especially after such a powerful run in both Energy stocks (XLE) and crude, many analysts put current inventories in balance. Even with an 800k to 1 million barrel increase the ongoing problems for both Venezuela and Iran may help limit the downside.
Taking this conversation back to where it started, IMHO going to an energy overweight at this point in the cycle seems at best late.
The Summit
In other news, traders last week were preoccupied with the off again, on again summit between the President and Kim Jong Un. The subject was pretty well exhausted by the broadcast and print media but for now the meeting seems back on.
The White House has said that a “pre-advance team for Singapore will leave as scheduled in order to prepare should the summit take place.” In addition the former U.S. ambassador to South Korea met with North Korean officials in the de-militarized zone.
Despite the headlines, I think market eyes are looking for direction elsewhere. If you bought and sold your portfolio every time there was a new twist or turn regarding the summit you’d trade yourself right into the poor house. A year ago when there wasn’t even a summit on the horizon, markets were doing just fine.
Separating the Forest from the Trees
One last thought before we step into a shortened post-holiday trading week. Unable to completely break out of the trading range the S&P 500 (SPX) has frustrated both bulls and bears. Maybe it’s time to focus on the trees rather than the forest.
It’s hard to make a compelling case for the broad index with valuations at historic norms. In a recent TV interview legendary investor Leon Cooperman said it best pointing out the market is “fairly valued.” However, the tide doesn’t have to lift all boats to make money.
Norfolk Southern (NSC)
There’s plenty of ideas beyond the crowded Tech and FANG trades. Here’s just one. Rails and trucking touch almost every sector of our economy. Industry publications like Railway Age put intermodal rail volumes at near record levels as trucking rates edge toward historic highs. Norfolk Southern (NSC) has already announced 15% increases to non-contract intermodal freight prices. Not terribly cheap at 17x 2018 EPS but with earnings and revenue up 31% and 6% respectively a nice diversification for your portfolio and a far less crowded trade.
*At the time of this article some funds managed by David Nelson were long NSC
