Oil Markets in Review: October

Just about a month ago, analysts were clamoring about the historical prospects of October where indexes typically saw the worst performance of the year. And as if it actually meant anything, reports began to tout the negative outcomes that the first month of the third quarter could produce, especially after the dismal performance of the quarter before. It seems elementary to believe the independence of monthly statistics, but some investors can't help but attribute a kind of seasonality to the apparent pattern. Once again, though, there could have been some sort of contrarian sentiment underneath the bearish rumbles. Some people may forget about that equal and opposite reaction prominent in physics, but like anything with momentum, the adage can apply in financial analysis as well. The concentrated efforts of the bears in the third quarter have diminished and given way to short-term and long-term bulls that traded in the way of the bull market birthed at the end of the financial crisis of 2008. It seems as though we've seen the worst of the year with the lagging biotech sector flattening out, commodities posting more gains, and the energy sector leading broad-based increases when they come. Looking at the numbers, the monthly gains actually prove to be some of the highest in years. Th U.S. large-cap index, the S&P 500 gained about 8.3% this month as the index surges over its 2,000 level despite a -7.58% loss accumulated in the third quarter. The Dow Jones Industrial Average saw similar gains, in October, with the index growing 8.47%. But the bounce off of third quarter disappointment wasn't apparent just in the United States, European markets jumped this month as well with help from the ECB's love affair with quantitative easing. Investors traded the France CAC 40 up 9.93%, the Germany DAX up 12.32%, and the Netherlands AEX up 9.73%. The Euro Stoxx 50 shows the systematic bullish fervor that encapsulated the European states with a growth of 10.24% countering losses of -11.3% in the third quarter. China's initial weakness has appeared to waver as well with an October surge of 10.8% following losses of -24.7% in the third quarter. The difference shown by the numbers are astonishing with a month of gains canceling out almost three months of bearish movement in some cases. As bearish sentiment and volatility sought to chase investors out of the market, the bullish streaked October brought more back. Third quarter months averaged 13.01 billion shares traded a month, a statistic that was topped by the girth of October trading at 15.27 billion. The heavier volume statistic can probably be explained by the popularity of trading around earnings season which was in full swing by the close of the first Q4 month. Although earnings and sales have been generally lower, smaller expectations have caused there to be more surprises, and thus, more bulls. All sectors have felt this surge with their constituents in the S&P 500 all in the green for the past month. Utilities, the worst performing in October, grew 1.05%, but materials and energy each led the market at 13.45% and 11.25% respectively. These two sectors lead the rest even though their price to earnings ratios rose throughout the third quarter. Because of this, some analysts are wondering whether the current market prices are overpriced despite relief from the economic slowdown that plagued third quarter performance. Although, others would argue that recovering commodity prices will help repair revenue deficiencies from companies that rely on price to retain earnings. That seems unlikely, though, as inflationary pressures quickly turn to nil and threaten the strength of the labor market that will probably experience little to no wage growth. In September, personal income in the United States grew a meager 0.1%, falling to its expected value of 0.2%, The September value was 0.3% less than the past five months which each experienced growth of 0.4% in their respective months. Optimists, though, point to the rebound crude oil prices made in October. In 2015, the supply glut causing low energy prices has been the blame for a decrease of cash flow in the economic environment.  Consumer prices have, in turn, dropped an average of -0.01% a month for the past twelve months. These statistics are the main reasons for the Fed's dovish monetary policy even though employment statistics has pretty much reached full capacity.

So where does the energy sector go from here? A sector with YTD return of -12.9% certainly has some upside to it, but only what crude oil contracts have allowed. Many might attribute the October rebound to bears cashing in on shorts or bulls taking advantage of oversold equities. For that reason, the gains of the past month could be considered due to technical strength helped along by earnings trading. Exxon and Chevron, which both grew at about 1% on Friday, have total losses of -10.50% and -18.17% respectively for the year. These companies, with the best credit ratings of the industry, have shown that even they are vulnerable to price changes. Whether or not their (and their peers') October gains are due to technical strength is undecided. We do know that fundamental changes cannot be the case as P/E levels have only risen. Perhaps the gains are attributed to bets for the recovery of the crude oil price. Brent and WTI prices both had a bullish month, gaining 2.33% and 3.42% respectively, with most of the trades being fueled by production and stock data released weekly. The performance in October was supported with tapering volume statistics as open interest tapered off from September highs. Short positions established also reached a new high by the end of October with long positions remaining flat. Price forecasts for the end of the year are $51.35 according to Factset. These figures may seem plausible as production is set to drop off due to the possibility of defaults and a reduction in investment spending from all oil and gas firms. We'll end this October review with a ratio comparison of WTI and the S&P Energy index as well their technical drivers.

Coming into the summer months, the energy sector and WTI contracts correlated pretty weel with neither outperforming the other. In July though, there is a clear shift to the energy sector outperforming the gains or losses of the WTI benchmark. This could be attributed to energy stocks being oversold while WTI was experiencing an increase in oil production. This lead to a high in outperformance from the energy sector, but it was soon to be corrected. The chart makes a V-shape, showing the disparity between what energy stocks traded at and the capital limitations they saw due to low oil prices. The two converging blue V-patterns exhibit a small bubble, perhaps, where energy stocks (especially oil and gas firms) were overvalued compared to oil price and subsequently corrected. The October correction appears to be a smaller form of the correction which bottoms quicker than it gains. I suspect the fourth quarter may follow some of the same cyclical movement as WTI finds its appropriate spot price for the end of 2015. The energy sector, so far experiencing a great fourth quarter, may be more linked to oil price through the end of the year as its performance converges into correlating with the oil benchmark.