Traders Raise Bets Against Energy Stocks, Fearing Rally Will Fade
Short interest in the S&P 500’s best-performing sector rises to its highest level since 2020
More traders are betting that energy stocks’ big 2022 rally won’t last.
Short interest in U.S. energy stocks has risen to 3.9%, the highest level since October 2020, according to S&P Global Market Intelligence. That means that 3.9% of energy shares available for trading are being held by short sellers. Such traders profit off a stock’s decline by borrowing shares from a brokerage for a fee, selling the stock and then buying the stock and returning it to the brokerage to close out the position. Within the energy sector, traders are the most short on drillers and companies refining and marketing oil and gas and the least short on transportation and storage companies.
In comparison, the average short interest across the entire S&P 500 sits at 2%, according to S&P Global Market Intelligence.
The simplest explanation of traders’ growing pessimism regarding energy shares is a belief that a group of stocks is generally due for a pullback after a big rally. Energy stocks have run up more than any other sector in the S&P 500 this year, thanks to oil prices surging after Russia’s invasion of Ukraine. Even after giving up some of its gains, the S&P 500 energy sector is up 53% this year, compared with the S&P 500, which has fallen 22%. It remains the only sector in positive territory for the year—a stark reversal after years of underperformance. Some traders believe that kind of dominance can’t last.
Energy stocks’ naysayers note that oil prices have fallen well below their highs of the year. Many investors have grown increasingly worried that the global economy, which is facing strains from rising interest rates and slowing consumer spending, will fall into recession next year. That has kept a lid on oil prices over the past couple of months because demand for oil tends to wane when business activity cools down. Brent crude settled at $92.41 a barrel Wednesday, down 28% from its March high of $127.98.
Despite a dimming economic outlook, many on Wall Street still believe that energy stocks have more room to run.
Goldman Sachs is recommending that investors keep a larger-than-average position in energy stocks in their portfolios.
A team at the bank led by chief U.S. equity strategist David Kostin noted that energy stocks’ performance has typically been closely correlated with the price of oil. With Goldman projecting that Brent crude will climb to $115 a barrel over the next six months, in part because the Organization of the Petroleum Exporting Countries and its Russia-led allies agreed to significant production cuts earlier this month, energy companies should be able to keep generating above-average earnings growth, the analysts said.
Major oil producers including Chevron Corp. and Exxon Mobil Corp. reported record profits last earnings season and are expected to keep posting strong results through the rest of the year.
Goldman said energy stocks have historically been the biggest outperformers in the stock market when economic growth has been below average and inflation has been higher than expected. Those are the exact conditions many investors fear they might be grappling with next year—which would likely put a damper on the broader stock market, but possibly keep energy stocks’ dominant run going in 2023.