As investors we can do all the homework necessary to find opportunities. But sometimes the game becomes rigged – pun intended – thereby putting us at risk. Today my mission is to suggest that there are stocks to avoid in the energy sector.
This will be a tough sell because prices there are incredibly strong. My contention is that they are too strong and not for good reasons.
Wall Street is not an equal opportunity setting, which is fine to a degree. But sometimes the severity of the situation creates too great a risk for the home gamers. They should leave a trade, especially when there are warning signs.
First, it is important to know that I am not a perma-bear. In fact, when investors ran away from two of the stocks today, I jumped in. I did that during the pandemic crash, then last September. That last trade alone delivered 35% of upside. Clearly I don’t have a hidden agenda other than to suggest booking profits. Success starts by sniping an opportunity before the masses. But also it often relies heavily on knowing when to leave the game.
Let’s review a few facts about the consumption trends on oil. Coming into the pandemic, the world consumption of oil grew 1.2% per year between 2006 and 2019. This is hardly an explosive trend by any stretch. Then the world stopped working in 2020 and that fell into a pot hole. Currently, the consumption is still below 2019.
Add to this that all major car makers have committed to end production of fossil fuel vehicles inside a decade. This will likely severely stall the growth curve of oil consumption. Moreover, zooming and telecommuting have sharply cut the daily business foot traffic. Check around your personal situation, and you will probably realize how much less we are all driving.
All major governments have overtly committed to going green on all levels with solar power. Chasing low carbon footprints is now a trend that has momentum. Alternative power sources like solar power are likely to become more ubiquitous, thereby reducing the need for fossil sources. Any which way you slice it, the world has unequivocally decided to use less of the stuff. The long-term demand story is not one that suggests boom.
Meanwhile, oil stocks have exploded into a frenzy that is not likely to end well. Today I present three stocks to avoid in case the music stops playing. I am not suggesting to short these companies but rather avoid them or book profits. They are:
Stocks to Avoid: Chevron (CVX)
At the depth of the pandemic crash, I wrote about an upside opportunity in CVX stock. Part of my thesis was that it’s a quality company that pays a great dividend. Moreover, the CEO overtly defended the dividend to the end. That was $33 lower and now the situation has become too bloated for my taste. Since then, the yield has dropped considerable, thereby making better risk-reward stock available. AT&T (NYSE:T) comes to mind for one, which still pays 8%.
Coming into the pandemic, the 2019 gross profit of $19 billion was nearly half of 2014. Clearly the fundamentals were already deteriorating even when we had none of the current changes in consumption. Telecommuting then was still a joke, and the world was only halfheartedly intent on greener ways. This means that now the fundamental situation is much more difficult than 2019, yet oil stock cannot stop rallying. This makes no sense, so the least I can do is put this one in the basket of stocks to avoid.
I don’t want to short it, because clearly we are dealing with illogical behavior. This is a fight to avoid altogether since we are clearly missing a puzzle piece. And here comes the shocker: For a trade, if CVX stock sets a new all time high (above $136) it could rocket much higher. This would be a technical opportunity for those who can trade fast. Else I would consider re-engaging long when it falls into support near $106 per share. It might take a while to get there, and so be it.
Exxon Mobile (XOM)
Almost everything I noted about CVX stock above applies here to a tee. Therefore, it is not shocking to learn that I also shared bullish opportunities on most significant dips. The argument always involved the healthy dividend and the management’s commitment to it. Both companies cut their cap-ex programs immediately to preserve cash during the crunch. And they also guaranteed having more spending they could cut further.
I have absolutely no beef with the success of these two companies. Between XOM and CVX, I would cut CVX stock out first. XOM stock is no where near as aggressively high as Chevron. For some reason, XOM stock remains 31% below its all time high. The problem is that it is running into a big prior fail points. There are resistance levels from the pre-pandemic price necklines. Moreover, there is the problem of heavy supply above $80 per share. They say that price is truth, well that’s where lie the heaviest volumes at least since 1981.
I liked owning XOM stock from lower levels and it was a two-fold trade setup. Back then it had suffered big falls due to temporary problems. Also it offered its owners a 9% reward to boot. Now that yield has fallen to 4.9%. Although still healthy, it is no longer exceptional. This is especially true if I am right about its stock precarious position. Having a 5% reward is no good if the stock drops and costs you more.
Stocks to Avoid: Whiting Petroleum (WLL)
Of the three today, this is my least favorite long. I remember helping a friend trying to manage a loss in 2020 when WLL stock was crashing. Now it is crashing up and for no good apparent reason. The company went bankrupt in 2020 then emerged from it and comes back public that same year. Since then its stock is breaking records incessantly. That is the kind of mojo that puts it atop of my list of stocks to avoid forever.
Ignore my opinion and let’s lay out the facts. The stock now is 170% higher than its first week back into the living. Meanwhile. its sales are less than half of 2014 levels. Don’t confuse my caution about the stock level with bearishness about the company’s health. It is booking sales and netting some too. My beef is with the altitude of the WLL stock and nothing more. I am sure the company is doing its best at making this comeback stick.
Earlier I sounded grim about the fossil-fuel prospects. The truth is that I am a realist about the ESG progress overall. I bet the conversion will take decades, not years, and that we will continue to need oil. EVs are not going to replace the internal combustion engine. The current battery production levels are not likely to support producing 90 million new vehicles per year. Nevertheless, my warning today is about the potential that this rally in energy stock may come to an abrupt halt.
Here is another thing to consider that could adversely affect these three stocks to avoid. The indices are near record levels and the experts are warnings of market tops. While I disagree, their warnings are not that crazy. If indeed we do suffer a market downturn, investors will sell the froth first. This is where LIFO (last in first out) method could decimate these three late running stocks. I would rather miss out on upside potential than be the last bag holder.
On the date of publication, Nicolas Chahine did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Nicolas Chahine is the managing director of SellSpreads.com.