The Crash in Oil Presents a Singular Opportunity

We made it through another week! Hope you and yours remain healthy and safe. Today, we’ll discuss the how the dramatic plunge in oil prices has precipitated a unique opportunity in the XLE. We’ll also provide our weekly market and factor updates.

‍The XLE Barely Has Any Exposure to Oil

‍As we all know, prices of WTI crude contracts (for May) hit negative territory on Monday for the first time ever. This move, combined with the spike in worldwide risk and ongoing OPEC+ drama, has generated an interesting proposition for energy-minded managers.

Let’s first look at how risk in the XLE has evolved recently:

‍Energy Select SPDR (XLE) Risk, Trailing 1 Year

Obviously, total risk for the XLE has spiked, now sitting at 51%. Using the Axioma US Macro Risk model, we can see how Oil risk has trended for the XLE:

Somewhat surprisingly, as oil prices have fallen, so has risk for the XLE. Now, using the same macro model, let’s look at historical exposure to Oil for the XLE over time.

It becomes apparent that the big increase in this risk looks to be coming from Equity contributions, offset by Core Macro factors. At the same time, the contribution to risk and exposure coming from Oil has dropped dramatically, as overall ETF risk has jumped up so high because of overall equity risk.

Thus, the Energy sector is unintuitively carrying close to zero exposure to Oil. Which means you can think of purchasing shares in a basket of energy stocks, i.e the XLE, as a cheap call option. While we expect to see volatility in the future, right now our models aren’t predicting any risk from Oil because prices are so low. This presents a unique buying opportunity where there is seemingly nothing but upside, as you’re buying the energy sector without any exposure to oil.

All told, due to its ridiculously low price, oil is now contributing a very small percentage to overall market risk right now. Hopefully we can agree that regardless of the long term trend, there’s still future value in oil, as it’s not going to simply disappear tomorrow. So while the rest of the world tries to figure out how to buy and store barrels of oil for their pool, you can just buy the XLE without the risk or mess.

US & Global Market Summary

US Market: 4/17/20 - 4/23/20

• After a mixed week, most of the major indices declined on Friday as investors reacted to 1Q20 earnings reports and oil’s collapse into negative territory.
• The US COVID-19 death toll (highest in the world), exceeded 50k on Friday after doubling in 10 days, as the number of infected Americans surpassed 900k.
• On Friday, Apple (AAPL) and Microsoft (MSFT) both saw strength ahead of their 1Q earnings next week amid talk of each releasing their own beta COVID-19 tracing tools.
• The CBO released sobering projections on Friday, predicting that the US unemployment rate will average 15% over 2Q20 and that GDP will decline by ~12%. Interest rates on 3-month T-Bills s and 10-year Treasuries are expected to average around 0.1% and 0.6%, respectively. They also forecast national debt to increase to $3.7T in FY2020.
• On Thursday, the House passed a $484 billion spending bill to replenish the new but swiftly depleted program providing loans to small businesses, as well as further funding for coronavirus testing and hospitals.

Factor Update: Axioma US Equity Risk Model (AXUS4-MH)

• The rally in Volatility continued as it now sits on the edge of Overbought territory at 0.8 SD above the mean.
• Growth also saw a recovery to the tune of +0.57 standard deviations as it headed back to the mean.
• Market Sensitivity became an Extremely Overbought factor, now at 2.18 SD above the mean. This factor was at -3.45 SD below the mean on March 18th.
• Earnings Yield (another proxy for Value) slowed down, effectively remaining neutral over the course of the week.
• Size continued to fall from a peak of +3.2 SD above the mean on 3/18, exiting Overbought space and sitting at +0.51 SD above the mean.
• The fall in Profitability persisted, as it fell over one standard deviation while remarkably retaining an Overbought label (recent peak was +6.47 SD above the mean on 3/20).
• US Total Risk (using the Russell 3000 as proxy) decreased by 39bps.

Factor Update: Axioma Worldwide Equity Risk Model (AXWW4-MH)

• We’ve spoken extensively about Exchange Rate Sensitivity, which saw a nearly +1 standard deviation move over the past week, yet still sits in Extremely Oversold territory
• Growth enjoyed a sizable rally, and now sits at the mean at -.02 SD below the mean.
• Worldwide Volatility saw another big move, vaulting to the threshold of an Extremely Overbought designation at 1.99 SD above the mean.
• Market Sensitivity also saw a +0.57 SD move, and is officially an Extremely Overbought factor at +2.32 SD above the mean.
• Value continued to recovery internationally, living in positive normalized territory for the first time since mid-January.
• Earnings Yield moved down by 0.82 standard deviations yet still remains in Overbought space.
• Profitability continued to plummet by almost a full standard deviation, shedding its Extremely Overbought label.
• Size was the biggest loser as it continued to revert, falling from 1.3 SD above the mean towards the mean and leaving Overbought space.
• Global Risk (using the ACWI as proxy) declined by 40bps, in line with the US.

Regards,
Omer