As I write this on Tuesday afternoon, West Texas Intermediate Crude is up 6.5% after having put in large gains the previous two days. Last Thursday it was around $44.58 and right now it is $52.76 which makes for an 18% gain in three trading days.
We have watched the decline in crude noting the slow decline that started in June that then turned into a crash starting at around $75 at Thanksgiving. The circumstances of crashes are always “different” but the market action is very similar almost every time and the oil market is showing the same pattern for now.
The usual arc is a crash which triggers an emotional response begetting more selling and then the extrapolators coming out and telling us why the price move will go much further in the same direction, in this case there were calls for $25-$30 per barrel. Then for no reason at all the price turns in the other direction and snaps back very quickly.
Also typical of these types of headline grabbing moves is a parade of portfolio managers on CNBC who traded this exactly right and have no exposure. I imagine that if the move to $52 is sustainable or keeps going then there will be another parade of portfolio managers on CNBC who all loaded up with overweight positions last Thursday below $45.
The point here is not to make a prediction about what oil will do but to take this as a learning opportunity for market action that very frequently repeats. I made a couple of small changes to the volatility of my energy exposure a couple of months ago but nowhere close to zero exposure because while I had no idea how low oil prices would go the selling was clearly emotional and emotional selling often stops for no apparent reason and prices retrace some large portion of the crash very quickly (repeated for emphasis).
It would have been great to have loaded up on energy stocks last Thursday but I didn’t but by not going to zero I am capturing the lift that has been happening in the last three days. As one of the big market sectors, energy is a big portion of a diversified equity portfolio and going to zero, as we’ve talked about many times before, is a big bet and big bets by definition are risky.
I looked at a couple of domestic energy sector ETFs which are both up about 7% in the last three days. Did any of the pundits with zero exposure last week buy today? If so what happens to those ETFs if oil goes right back down to $44? If they did not buy back in, what will happen to those ETFs if crude goes back to $75 or $100? When do they get back in?
This is a great example of why I believe zero is a big bet not worth making.