The Long-Awaited "Floor" (and Where It’s Showing Up First)
I am in the U.S. Airways club at LAX, awaiting a flight back to Charlotte and then on to Pittsburgh. I had to get here a little early to beat the traffic jam in downtown LA because of the Stanley Cup victory parade.
The Kings… who would have thought that was possible, just a month ago? Just goes to show you that anybody can get hot at the right time.
Which, as you probably suspect, is my tortured segue into discussing the markets.
As I write this, it is early afternoon Eastern Standard Time on Thursday (June 14). The Dow is up 120, after falling 77 yesterday, up triple digits on Tuesday, and down triple digits on Monday. If today holds on, this will be the third 100-plus point performance in four days.
Such a rollercoaster ride is enough to make your stomach turn.
While market uncertainty continues, and the averages trade within a range (admittedly, a triple-digit point range on the Dow), we certainly will be confronting more volatility ahead.
And that is especially true as the following events get ready to converge:
- The Greek election is on Sunday;
- Meetings in Moscow on the EU embargo against Iranian crude oil begin on Monday;
- Customer withdrawals from banks in Greece and Spain continue;
- Calls for greater European integration come from one end of the continental political spectrum (read: Italy and Spain here); and
- An insistence for greater control over other countries’ finances (the persistent Achtung coming from Berlin) come from the other end.
For just these reasons, it’s guaranteed that the volatility will continue to provide for a choppy market.
But there is one more intriguing matter afoot.
This one places nicely (and finally) into our investment perspective.
Absent another wave of crises, there is another major development fast approaching.
A floor is forming in the energy sector.
The Energy Pop Will Outperform a Market-Wide Recovery
As I have noted on several occasions during this often tumultuous two months, the energy sector was punished more harshly than the market as a whole while prices were retreating. On the other hand, when the averages are moving up, energy tends to lead the way up.
Remember, that’s in part because the index of leading economic indicators is where we go to estimate the direction an economy will head. The composites of that index usually register a performance improvement before the broader economy (or market).
These indicators are also energy-dependent. This means that when they move up, the expected demand for energy does as well. That performance will also precede the uptick in the economy as a whole.
And that is (finally) beginning to happen.
Combine this with the significantly oversold condition among energy stocks, and that translates into a pop in the sector about to unfold. And this pop will register much higher returns than any market-wide recovery.
The problem with all of this is the same: How do we know when the floor has been reached?
The Challenge of Finding the Market Bottom
Well, this is always a judgment call. Most identifications of the bottom are made retroactively and then, only after a sufficient period, allowing for the crunching of data.
However, we normally have a key when it comes to identifying the floor in energy.
Here’s the deal.
The establishment of an energy-pricing floor will not kick in across the board at the same time. It will, on the contrary, appear first in that energy component most likely to be drawn upon first as a wider recovery rolls out.
This could be crude oil or natural gas extraction, for example, field services, storage, transit, or other midstream companies, and so on.
This time, we are seeing it unfold in the generation and distribution of electricity. Here power providers have had the advantage of low natural gas prices and adequate “spark spreads” – the difference between futures contracts for an increasingly used fuel base (gas) and those for peak and off-peak provisions of the electricity itself.
While oil continues to find itself mired in the geopolitical uncertainty of Europe, Iran, and the latest OPEC gathering, electricity has emerged as the sector with the most direct impact on economic prospects moving forward, at least on a short-term basis.
Utilities have been recovering for a while. But, given the cross currents over the past several weeks, they had been signaling a segment-specific recovery more than anything else.
That phase will soon end.
All of the more than three dozen electricity generators and/or distributors on my tracking lists have shown positive returns this week. Even during this very unstable month, they have remained in positive territory (or essentially flat, at worst).
As we move into the high summer when electricity usage tends to increase, prospects remain for additional advances. But remember, I am not calling for investment in a broad range of stocks here.
Instead, I am using this advance to indicate a floor is forming in the energy sector itself.
Soon enough, that will provide us with an even degree of leverage.