There could be little room for more upside to stocks following the recent rally, but if oil prices continue rising, perhaps 2016 will become a little brighter for them. However, there is a limit, and if they get too high, it could be seen as a negative, particularly for growth stocks. Today isn’t doing anything for oil as WTI crude, Brent crude and Tokyo crude all declined. They continue to hover around or below $40 per barrel.
Stocks are no longer in oversold territory, according to HSBC analysts, who interestingly enough are overweight on Energy stocks, basing their contrarian view on their expectation that oil will stabilize. They don’t think the recent stock rally is sustainable, at least as things currently stand.
In their March 8 Global Equity Insights report titled “Nine and a Half Questions, HSBC strategist Ben Laidler and team address a number of issues investors are asking questions about right now. They note that the world’s equities have rallied 10% from the late January lows of the MSCI ACWI, adding that the size of the November to January correction was near the 16% historic average and that we’ve only see 15 of these since 1988.
They’re currently expecting 7% upside to their global equity target for the end of the year, so they currently recommend being “moderately long” on equities. However, they still think any gain will be difficult, although they also believe the concerns about global growth and a policy mistake by the U.S. Federal Reserve are overdone.
“The bigger picture is that the equity cycle is extended – earnings are high overall, valuations full, equities well-owned, and policy flexibility stretched and becoming less effective,” they wrote. “We cae into the year with only a +4% index target, so the current upside comes from the sharp market sell-off, in excess of a decline in fundamentals, and with overly depressed sentiment, in our view.
Higher oil prices might be a positive, but only “up to a point”
The HSBC team thinks it’s possible that we’ll start to see less selling as the selling of the commodity sovereign wealth fund was blamed for much of the recent selloff even though data to support this view is “scarce,” they said. They believe oil prices are stabilizing and will gradually move higher, which could mean that the “perceived selling” will come to an end.
They noted a very interesting correlation between tumbling oil prices and stock prices. Aside from sovereign wealth fund selling, worries that low oil prices reflect weak demand are also being blamed for the recent selloff.
Low oil prices correlated with low stock prices
However, they said the correlation between oil prices and equity prices only reflects the “nervousness” of the market, as “the shorter term costs of falling oil prices to corporate earnings and Energy sector capex [are] outweighing the greater medium term support to the Developed market consumer.” They think shock from supply and inventory drove the fall in oil prices. Further, they note that oil prices have dropped off much more than the “broader commodity complex,” which they say supports their view. Brent crude is down 36% compared to last year, while the Dow Jones Commodity Index declined 16%.
If oil prices rally significantly, however, the HSBC team expects a shift in the stock markets from growth stocks to value stocks following value’s six-year underperformance. They don’t think a big move in oil prices would be seen as a very big positive though and that it would traditionally be seen as a negative in terms of growth. They’re expecting oil to reach $55 per barrel by the end of the year.
They add that their contrarian overweight view on the Energy sector would be supported if oil prices stabilize. They think valuations in the sector have overshot and that it has the highest dividend yield of all the sectors. Further, they think sustainability of that dividend is higher than what the market thinks it is.
HSBC’s overweight recommendation on Energy stocks may not be contrarian for long though as data from S&P Capital IQ indicates that hedge funds are flocking to them.