Is “Oil Risk” Making a Comeback?

Talks of an impending oil crisis have been making headlines over the past several weeks. Some argue that the “impending” crisis is already here, while others believe the worst is yet to come. The economic reopening has exposed major oil shortages, which has spurred oil prices to go on the run in tandem with increased global demand. These conditions, coupled with the global supply chain disruptions and labor shortages for related industries, have already led to panic ensuing in some locales.

There’s no question that investors should be concerned about the possible global shock that could come from the continued tumult surrounding oil supply and demand. Using the Axioma Worldwide Macroeconomic Projection risk model, we can quantify the sensitivity of assets to macro factors, including Oil.

Quantifying Rising Sensitivity to Oil

The Axioma Worldwide Macroeconomic Projection (“Axioma Macro”) risk model combines the traditional style, country, and currency factors from the Worldwide model with additional market-traded macroeconomic factors across Interest Rates, Inflation, Corporate Credit, and Commodities. Of particular interest for our analysis will be the Oil factor, measured by the returns of NYMEX WTI Crude Oil 1 month futures.

To build context around the Oil factor, we reviewed the factor exposures across a sector that intuitively should not only have sensitivity to oil prices but likely has seen that sensitivity increase over the past several months as the supply and demand issues have emerged.

The above box-and-whisker plot shows the distribution of exposures for the Oil factor for a universe of US Energy stocks with a market cap above $500M and average daily trading volume above $5M. Right after the COVID market downturn in the late spring and early summer of 2020, we can see that the exposures plummeted, illustrating the breakdown of the relationship between energy producers and oil. During this time, the median stock only had an exposure of 0.01, and the bottom 25-50% of Energy stocks actually had slightly negative exposures.

Fast-forwarding to the last few months of 2021, we see that not only do all stocks in our Energy universe have positive exposure to Oil, but these exposures have been sharply trending upwards. The median stock now has an exposure of 0.2 to the Oil factor, which is a 2,000% increase!

Considering the Oil Risk Perspective

One might note that even though the Energy sector exposures to Oil are currently positive and trending upwards, they are still lower in magnitude than we would typically expect from traditional risk model factors. However, if we consider the magnitude of returns and volatility of oil prices, the “low” exposures start to make more sense. A view of the returns since the beginning of 2020 shows that the Oil factor has been very volatile and has also hit normalized returns that have exceeded +/- 2 standard deviations five times during the period.

Given this, it’s important to consider asset exposures to Oil and the risk contribution coming from Oil, which takes into account the volatility of the factor.

A look at the risk profile of XLE illustrates this point. The current contribution to predicted volatility for XLE from the Oil factor exceeds 15% and is now an even higher risk contributor than the Inflation factor.

The increase in Oil risk has propagated to other industries, such as Industrials, where the risk contribution has increased by 55% since the end of Q2 alone.

Though the overall risk contribution is currently sitting at only ~2.7% of XLI’s overall volatility, it’s possible that if the oil crisis continues, this could accelerate rapidly in a short time.

While it remains to be seen how the oil crisis will play out, it does appear that oil risk is coming back in full force and is unlikely to dissipate as the economic reopening continues to progress. With macro drivers here to stay in the current market environment, investors need to be cognizant of the underlying macro risks in their portfolios. If you are interested in further exploring your portfolio’s macro risks, please feel free to reach out to us directly.

US & Global Market Summary

US Market: 10/18/21 - 10/22/21

• Strong corporate earning helped all three major indexes notch weekly gains for the third straight week.
• Digital World Acquisition (DWAC) shot up 357% Thursday on news that it would be the SPAC merger partner for Donald Trump's new social media venture.
• Stocks came under pressure Friday after Federal Reserve Chair Jerome Powell said the U.S. central bank was "on track" to begin reducing its purchases of assets.
• Consistent with our main topic this week, oil prices kept soaring. Brent crude oil jumped for the ninth straight week, near its high of the year.
• Apple Inc, Microsoft Corp, Google parent Alphabet Inc, Amazon.com Inc and Facebook Inc are all set to report earnings next week.

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

• Size zooms to our top spot this week leaving Oversold space in the dust and now sits at -0.51 SD below the mean.
• Growth continues its reversal following recent weakness and exits Oversold status this week as well.
• Earnings Yield made a strong move up yet again but drops down two spots after its 2-week reign atop the leaderboard as it approaches the mean.
• Profitability showed strength landing just below the Oversold threshold at -0.95 SD below the mean.
• Market Sensitivity (Beta) eked out a small gain and climbed for the 8th consecutive week.
• Medium-Term Momentum fell for the 6th straight week.
• Value moved further from Overbought terrain and finishes dead last for the 2nd straight week.

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

• Akin to the US leaderboard, global Size takes this week’s top spot and now sits at -0.43 SD below the mean.
• Profitability jumps following a three-week period of little movement.
• Earnings Yield and Growth both had a strong week barely exiting Oversold status, landing at -0.99 and -0.96 SD below the mean respectively.
• The bottom spot also mirrors the US leaderboard as Value continues its recent reversal, exiting Overbought territory and now sits at +0.63 SD above the mean.

Regards,
Alyx