What Really Moves Energy Stocks?

The question "What really moves energy stocks?" invites a response along the lines of, "Energy, ya big dummy!" But let's eschew such inelegance and see whether the answer really is that simple. And, while we are at it, let's take another look whether commodity-linked equities are an effective way of trading the underlying commodity.

Factor Contributions

First, let's go back to a factor analysis first introduced in February 2005. The relative performance of S&P 500 (SPX) industry groups can be regressed against a set of primal market factors. The statistically significant (90% confidence level) betas of the five oil-related groups within the S&P 500 against a set of 12 different market variables are presented below.

Primal Market Factors' Contribution To Energy Industry Groups

Click here for larger image.

Source: Bloomberg

Betas against two-year note yields and the VIX are negative; as yields rise, the energy stocks underperform. There are no statistically significant betas against 10-year-note yields. The most positive betas are against the shape of the yield curve as measured by the forward rate ratio between two and 10 years -- the rate at which we can lock in borrowing for eight years starting two years from now divided by the 10-year rate itself -- and against the Canadian dollar.

What about crude oil and natural gas? Surprisingly, their betas, highlighted in cross-hatch and diamond patterns, respectively, are rather middle of the road. This is our first clue to follow.

Respective Rankings

Now let's expand the universe from S&P 500 industry groups to all of the stocks in the S&P 1500 Supercomposite energy services index. The same color-coding scheme as used above (red for drilling, orange for exploration, green for equipment, blue for refining and violet for integrated firms) will be maintained and supplemented by gray for storage and black for coal.

The average annual returns for this universe from the Federal Reserve's declaration of war on deflation on May 6, 2003, onward are presented below. As a side comment, I was really quite surprised at how high these average annual returns were.

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Howard L. Simons is president of Simons Research, a strategist for Bianco Research, a trading consultant and the author of The Dynamic Option Selection System. Under no circumstances does the information in this column represent a recommendation to buy or sell securities. While Simons cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.

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