The Great Divergence Is Back
You don't have to be a rocket scientist to see how much energy stocks and oil are outperforming the broader market today.
Similar to the theme we've witnessed all year with a brief pause this summer, energy has been the place to be, and for excellent reasons.
Energy companies are returning record amounts of free cash flow back to shareholders through share buybacks and dividends.
Energy companies average a free cash flow yield in the mid-20s while other sectors are showing pressure on earnings.
Allocation to energy stocks remains near record lows with the index weighting around ~4.5%.
But while days like today are cause for celebration, I am here to ruin your fun. Arrogance is the easiest way to portfolio doom, and so, while there are bullish signs everywhere (as we have noted repeatedly in the last two weeks), we still need a few things to go our way.
Now don't confuse this with the main theme of this article, we believe the great divergence is here. Energy is set to outperform the broader market and its tech counterparts, but here's what I am still worried about:
Copper prices
China's "reopening"
Oil demand needs to keep trending higher
In markets, it's easy for us to conclude that once the price "does" exactly what we want, the fundamentals are somehow automatically aligned. That's not always true, so we would still need copper prices to start moving higher to persuade us that the market is starting to set aside concerns about global growth. In addition, our theory that China is set to end the zero COVID policy will actually need to turn into facts come the end of October.
If China decides to change its policy trajectory in any way, we would have to change our view on how demand rebounds. That's the nature of the market and there's no other way to go about it.
Now assuming that the things we highlighted do go our way, then the trend should be our friend. Energy is set to materially outperform tech going forward. Here's our favorite chart of tech vs energy:
