The worst may not yet be over for the energy sector after a sharp and sudden selloff in crude oil, but the carnage left behind is creating the sort of environment where a truly contrarian approach can work, according to one of Wall Street’s best-known technicians.
The U.S. oil benchmark last week slumped into bear-market territory, having fallen more than 20% from a nearly four-year high set on Oct. 3. Brent crude the global benchmark, is also in bear territory. Oil added to its plunge in Tuesday’s session before both grades bounced back more than 2% in Wednesday action.
A big drop alone doesn’t make for a contrarian opportunity, warned Jeff deGraaf, chairman of Renaissance Macro Research, in a Wednesday note. In fact, he cautioned that over the years a “perverse consensus” has emerged, in which “down is considered synonymous with contrarian.”
That may work on a tactical basis, he said, but drew a distinction between near-term bounces and “true contrarian plays” that offer durability. Those “one-decision” opportunities “are usually a byproduct of apathy, neglect and disdain,” deGraaf wrote. “Buying [Netflix, Nvidia or Amazon] might be tactical opportunities around short-term pressure, but not a true contrarian play,” he said.
So what about oil? Tuesday’s drop came with the biggest volatility spike for energy exchange-traded funds since the early 2016 selloff that took crude to the low of its post-2014 rout (see chart below).
Meanwhile, the uptrend for crude that’s been in place since 2016 has been broken amid “mass liquidation, while equal-weight energy names are at a new relative low to the S&P 500 and percentage of energy names trading above their 200-day moving average is not at a paltry 6.9%, he noted. At the same time, the number of 65-day lows shrank Tuesday after spiking a few weeks earlier, marking a positive divergence,” he said, as flows into energy-dominated ETFs like Energy Select SPDR hit “liquidation levels.” XLE is down 3.6% this week and has lost 8.7% in the year to date.
“It’s points like these, after years of underperformance and the inability to build sustained momentum that contrarian opportunities present themselves,” deGraaf wrote
While things can get worse in the near term, he said, pointing to the a correction in the Baltic Freight Index, “contrarian thinking is about seeing light where others see darkness, and that sounds about right in energy,” he said.
