Tag Archives: etfs

XLE: Energy Stocks Still Overvalued Relative To The Oil Price

Oil may find a bottom this fall at $35-$40 — but that doesn’t mean oil stocks will find a bottom. The XLE energy stock ETF remains highly inflated, as compared with the oil price. Oil and the broader stock market have been trading together since volatility spiked in August. If the S&P 500 goes down another leg to the 1680 range this fall, XLE will fall even farther than the S&P and the oil price will. Don’t buy oil stocks yet — in fact, consider shorting XLE. Ever since the oil price crashed in the fall of 2014, investors have been trying to call a bottom and find an opportunity to invest in the energy sector at bargain values. But so far, the market has frustrated would-be value investors in energy, as the oil price and energy stocks of all types have continued to fall farther and farther. The low to date was reached in the market selloff of August 24-25, when WTIC oil settled at $38.22 and the Energy Select Sector SPDR ETF (NYSEARCA: XLE ) fell to $59.22. Some investors are now hopeful that these prices were the bottom that they have been waiting for, and they think now is finally the time to buy energy stocks and make big profits on the oil price rebound in the coming years. I believe they are half right, but unfortunately it is not the most profitable half. The oil price itself was probably very close to the bottom when it fell into the $37-$40 range for a few days, below $40 for the first time since February 2009. But the large-cap and mid-cap energy stocks in XLE probably have a lot farther to fall. XLE was in the low $40s in February 2009, and it could fall another 33% from its current price before it reaches that level again. The point is that large-cap and mid-cap energy stock prices are influenced both by the oil price and by the performance of the broader stock market in general. Their prices were very low in February 2009 because the oil price and all stock prices were very low. Their prices held up relatively quite well from fall 2014 through spring 2015 because the whole stock market was holding up well then. Investors had confidence that the big oil companies would ride out the oil price drop and continue to prosper along with the entire economy when oil prices recovered. But since the return of volatility in all markets since August, oil stocks no longer have the assurance of the broader market to fall back on. Stocks have dropped decisively from their highs earlier in 2015, and the technical charts point to further declines coming this fall, which of course is a historically weak seasonal period for stocks. Numerous technical indicators signal that if the S&P 500 cannot hold support in the 1820-1867 range, a drop all the way to 1680 is the next likely step down. Moreover, in the current period of volatility, stocks and oil are trading together. When one goes down, so does the other. A bearish market trend and linkage of stocks and oil is very, very bad news for the energy stocks in XLE. One chart shows clearly how much more room XLE has to fall: (click to enlarge) This chart shows the ratio of the share price of XLE to the actual price of WTIC oil, over the entire history of XLE as an ETF, from 1999 to the present. Notice how elevated the XLE price remains today, as compared with the oil price. The ratio has retreated from its all-time highs earlier this year, but it still remains very high compared to most of the past decade and a half. If the broader stock market takes another turn for the worse, this charts shows that XLE has plenty of room to fall along with it, even after the oil price itself nears a bottom and stops falling so steeply. Notice in the chart that until last year, the XLE:$WTIC ratio normally stayed in a range from 0.6 to 0.8. With all stocks in a downward trend, there is no particular reason to expect that XLE will stay elevated above that range, and every reason to expect the likelihood of XLE returning to that range. For example, if the oil price settles at $40 and the XLE:WTIC ratio even returns to the top of the old range at 0.8, that would mean an XLE share price of $32, almost a 50% drop from its current price. If the oil price settles at $35 and the ratio falls to the bottom of the old range at 0.6, that would mean an XLE share price of $21, a 66% drop from its current price. I am not predicting that XLE will crash to $21 or even $32 this fall. I am just pointing out that it is well within the realm of reasonable possibility and would not represent an extreme change in the historical performance of XLE relative to the oil price. More likely is a decline to the low $40s or high $30s this fall, the range that XLE fell to in the crash of 2008-2009. The overall stock market would not have to crash 2008-style for XLE energy stocks to fall to those levels. The process will look very different because in 2008, stocks crashed first and then the oil price dropped, whereas this time the oil price dropped first and stocks are falling later. Actions to take: First of all, don’t buy oil stocks yet! The knife is still falling. More aggressive investors can consider shorting XLE. As a hedge, investors can short XLE and buy The United States Oil ETF, LP ( USO) to play a decline in the XLE:$WTIC ratio.

Staying Level-Headed In The Face Of Fed Uncertainty

By John P. Calamos, Sr. As we know, uncertainty about the Fed’s plans for raising short-term rates remains a key driver of market volatility. It’s understandable that investors are afraid to be in the markets and at the same time, afraid to be out. Whenever rates do rise (probably before the end of the year), there’s every reason to expect continued heightened equity market volatility. Even so, I view a more normal interest-rate environment as long-term positive – for the economy and for the equity market. Here are some points to keep in mind. Higher short-term rates should be viewed as an affirmation of U.S. economic health. The Fed has consistently expressed its commitment to a patient, globally-informed, data-driven approach. It will raise rates when it believes the U.S. economy is strong enough to continue growing without artificially low rates. The “path” of short-term rate increases is likely to be slow and shallow. In other words, I don’t believe we’ll see the Fed move to raise rates significantly and many times, provided that the overall economic landscape remains consistent with what we’ve seen over recent years – slow growth, low inflation. A more normal interest rate environment can support continued economic growth, particularly among smaller businesses. When interest rates are higher, lenders can earn more from borrowing activities. This should provide an increased incentive to lend to small businesses, especially against the supportive backdrop of continued economic growth. With increased access to capital, small businesses can grow and hire more people, contributing to better overall economic growth. Higher short-term rates don’t signal that we’ve entered a bear market. Earlier, I noted that markets are likely to remain volatile when rates rise, but that doesn’t mean there won’t be opportunities, especially for long-term investors who take an active approach. Historically, stocks tend to perform well during periods of economic growth (see point #1). Stocks have continued to advance after the onset of an interest rate increase, as Figure 1 shows. Moreover, as our Co-CIO David Kalis explained in his recent video interview , the prospects for U.S. growth stocks look especially attractive. (click to enlarge) Past performance is no guarantee of future results. Source: Cornerstone Macro. “Positioning For A Fed Tightening Cycle,” September 16, 2015. Convertible allocations may be particularly effective in this sort of environment. Because they have fixed income characteristics, convertibles may be able to mitigate the impact of short-term equity downside. And because they have equity characteristics, convertible securities generally demonstrate less vulnerability to interest rate increases than investment grade bonds. That means that when rates do rise, allocations to convertibles may prove more resilient. (Co-CIO Eli Pars outlines more of these potential benefits in this video interview .) It’s been observed time and again that markets hate uncertainty. That’s not likely to change. More importantly, what’s also not likely to change is this: volatility creates opportunity for those who can tune out the short-term noise and take a long-term view. Share this article with a colleague

Are You Afraid Of Rising Interest Rates? Here’s A Possible Solution

Summary The yield curve is an important graph that offers key information about the economy. Given that investors in a bull market are afraid of rising interest rates, other opportunities are being looked at. The Steepener and Flattener ETNs offer opportunities to take advantage of an increase in interest rates. The Fed recently decided to keep interest rates flat. But I believe interest rates will not remain flat forever. Therefore, it is worth taking a look at how someone could protect themselves against the rise of interest rates in the future. This article will focus on the characteristics of the yield curve with an emphasis on the Steepener ETN (NASDAQ: STPP ) and the Flattener ETN (NASDAQ: FLAT ). ETNs are structured products that are issued as senior debt notes, while ETFs represent a stake in an underlying commodity. These two ETNs are perfect opportunities to protect any investor against rising interest rates, as this surge will have an adverse effect on the stock market (NASDAQ: QQQ ). The Yield Curve The yield curve is a graph in which the yield of fixed-interest securities is plotted against the length of time they have to run to maturity. Here’s the current U.S. yield curve: (click to enlarge) Source: Treasury.gov . The short-term interest rates are administrated by the FOMC , while the long-term interest rates are created by the forces in the stock market. The Yield Curve Spread The yield curve spread is the yield differential between two different maturities of a fixed instrument. For example, the difference in yield between a two-year Treasury note and a 10-year Treasury note would create another line, a so-called spread. The later-maturity leg is considered a back leg and the leg that matures first is called the front leg . The spread between the two- and 10-year Treasury instruments has shown significant patterns over the last few decades, as seen here: Source: Forbes . The spread increases during bubbles, such as the tech bubble (1999-2001) and the mortgage crash (2007-09). This indicates that this strategy (taking advantage of the difference between the two- and 10-year yields) can be played out from time to time when equity markets might be under threat and heading toward a bear or bull market. This pattern is perfectly described below: (click to enlarge) Current times make things interesting, as interest rates are expected to increase in the future. This is a situation that has happened over and over again the last few decades: (click to enlarge) Source: Fed . As the graph above depicts, interest rates cycled upward and downward during the bull and bear periods of the economy. Yield Curve Strategies – Steepener and Flattener Source: Created by author. Flattener Strategy A flattening curve is a situation where the yields on the short-term and long-term dated treasuries are converging. In other words, they are coming closer together. From a bank perspective, this is not always considered favorable as banks borrow money at short-term rates while lending it out at long-term rates. When the yield curve converges, the short- and long-term yields come closer to each other and thus diminishing the profit for the bank. Yet, the steeper the yield curve gets, the higher the differential between long-term yields and short-term yields. That means more profit for a bank. When the yield curve becomes more flat, the iPath U.S Treasury Flattener ETN comes into play as it tracks the spread between the two-year and 10-year yields. One should not forget that these ETNs are leveraged, as a 0.1% move in the spread will indicate a 2% price change for FLAT . The flatter the yield curve gets, the better for the Flattener ETN. Steepener Strategy When the differences in yield in the short and long term are diverging (i.e., getting more steep), the iPath U.S. Treasury Steepener ETN is another option. The objective of this product is to hold a weighted long position in the two-year Treasury future and a weighted short position in the 10-year future, in contrast to the flattener. With a steepener you buy the spread, while with the flattener you sell the spread. They are opposites: Negative Rates As this article assumes rates will eventually go up, a potential scenario with negative rates — even though it has been deemed unlikely by Janet Yellen — should not be ignored. That’s because some economists believe the economy is still not growing as expected, and negative rates would basically indicate that anyone who wanted to borrow money would get paid. This would act as a potential strong stimulus to the economy. Even though it might appear to be an unlikely scenario at first, there are places in Europe that currently have negative rates in place, such as Switzerland. In the Fed’s projections, a negative Fed Funds rate was deemed plausible: Source : Fed . Summary Investors do not have to worry about a potential increase in interest rates as there are good investment vehicles to protect themselves against these potential rate hikes. As the yield curve has shown many predictable signs of explaining the economy , it’s important to keep an eye on how the yield curve develops over time. I currently do not hold positions in either ETN. However, both are on my watch list as I consider them splendid investment opportunities for when the equity markets dwindle lower or when the Fed finally decides to start increasing the Fed rate. Liquidity is a minor issue with both ETNs, but when interest rates eventually increase I expect liquidity to increase as well. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.