Why There Could Be More Recovery Upside To Oil Prices Than Stock Prices

The SPDR S&P 500 ETF Trust SPY has been red-hot in the past year, and alternative energy stocks have been among the top performers. DataTrek Research co-founder Nicholas Colas said Thursday investors shouldn’t be too quick to write off oil, and there’s evidence to suggest crude oil prices may have more near-term upside than stock prices at this point.

Don’t Write Off Fossil Fuels: In the daily DataTrek newsletter, Colas said he isn’t skeptical of the long-term growth opportunity for alternative energy but said investors should understand the sizable role fossil fuels will play in the global economic recovery in 2021 and 2022.

“We absolutely understand that the world is moving to decarbonize but remain skeptical that it will happen quickly,” Colas said.

In fact, he pointed out that the U.S. Energy Information Agency is projecting liquid fuel production and consumption will return to pre-pandemic levels within the next 18 months.

WTI crude oil prices are up nearly 200% in the past year to above $59 per barrel, but Colas said crude oil still looks cheap relative to the S&P 500.

Related Link: 3 Short Squeeze Candidates In The Energy Sector

The Numbers: Looking back at a long-term chart of the ratio of the S&P 500-to-crude oil since 1970 suggests previous peaks of 80x in 1999 and 2020 were excellent opportunities to go long oil and short stocks. Previous troughs below 15x in the late 1970s, early 1980s and 2010-2011 periods were great times to short oil and go long stocks.

Today, the S&P 500-to-oil ratio is at 64x, still two standard deviations above its average level from 2010 through 2019. Colas says the elevated ratio implies there is more upside to oil prices than stock prices in the near term.

“Even if you assume the 2020s will be a ‘new normal’ for crude prices and the average ratio has shifted up 1 entire standard deviation, the sustainable ratio would still be 46x (old mean 30, old st dev 16),” Colas said.

Even that conservative “new normal” valuation at a ratio of 46x implies a near-term crude oil price target of $87/bbl, nearly 40% upside from its current price.

Colas said the potential for oil price upside indicates upside for energy stocks as well.

Benzinga’s Take: So far in 2021, Colas’ call for energy stock outperformance has been spot on. Year-to-date, the Energy Select Sector SPDR Fund XLE is up 30.2% compared to just a 6.6% gain for the S&P 500.