A surprise deal by OPEC late last week to cut crude production sent energy shares soaring, offering good news for an increasingly endangered species on Wall Street: investors who buy these stocks based on their fundamentals.
Since the Sept. 28 decision by the Organization of Petroleum Exporting Countries, oil prices have surged, forcing traders to unwind positions that would benefit from a decline. Energy companies in the S&P 500 Index with at least 15 per cent of their shares borrowed for a short sale gained an average of 14 per cent, more than twice the return of the index's broader energy group, according to data compiled by Bloomberg.
Aided by a 4.3-per-cent pop on the day of the OPEC news, energy stocks led by Helmerich & Payne Inc. and Murphy Oil Corp. have been a rare bright spot for an S&P 500 that's virtually unchanged since the oil agreement.
Now that investors aren't so concerned that an unchecked surplus of crude will decimate the industry, traders can focus more on the individual attributes of energy stocks, according to Chris Verrone, head of technical analysis at Strategas Research Partners. That would be a major shift for a sector that's fluctuated on the whim of oil prices over the past 18 months.
"This seems to be a sector where stock-pickers are being rewarded for the first time in a while," Verrone said in a phone interview. "When there are concentrated short positions and an upcoming risk event, you have to be careful if you own those shorts. But with them now cleared out, it can actually be healthy for the market."
Among the group of companies sporting high short interest totals heading into the OPEC meeting were Helmerich & Payne, Murphy Oil and Transocean Ltd., which represent three of the seven lightest weightings in the 36-company S&P 500 Energy Index. That the biggest gainers were also among the gauge's smallest components is an indication of the breadth of the sector, another positive sign for stock selectors, according to Verrone.
"A lot of the leadership has come from down on the capitalization scale, and that's generally a good environment for stock pickers," Verrone said. "It suggests that, under the surface, there's a fairly wide population set from which to choose stocks."
Short interest on the SPDR Energy Select Sector ETF, which tracks energy stocks in the benchmark index, sits at 4.1 per cent of shares outstanding. That's one percentage point below the average for all major SPDR sector ETFs, according to data compiled by IHS Markit Ltd. and Bloomberg. The corresponding ETF for utility stocks, a sector that has slipped 7.6 per cent since reaching a six-week high in September, is currently the most shorted, at 8.4 percent of outstanding shares.
Going forward, investors in S&P 500 energy shares will have to contend with what's forecast to be an eighth straight quarter of weaker profits. The group is expected to see earnings contract by 65 per cent in the third quarter, according to strategist estimates compiled by Bloomberg. However the companies still may beat Wall Street's expectations since the outlooks has been so bad that earnings forecasts were cut by 27 percent, the most of any sector, a group of Morgan Stanley strategists led by Adam Parker wrote in a client note on Tuesday.
As earnings season approaches, trading volume in energy shares has ebbed after spiking amid last week's short covering. The S&P 500 Energy Index saw more than 88 million shares change hands in each of the three days following the OPEC announcement, up from its daily average of 63 million for the prior three months, Bloomberg data show. This week, the index has only seen about 50 million shares trade per day.
"With oil holding gains and volume surges allowing shorts to cover, moves in energy stocks from here will be real buying and selling," JC O'Hara, chief market technician for FBN Securities, wrote in a client note on Tuesday.