Pairs Trade: Bullish Energy Sector & Bearish Financial Sector – ValueWalk Premium
Bullish Energy Sector & Bearish Financial Sector

Pairs Trade: Bullish Energy Sector & Bearish Financial Sector

As of this writing, WTI crude oil is back above $65/barrel, closing in on the recent $66.33 high on January 26. While oil and US equities have been in a “wedge” formation where, hemmed in by the January 26 high and the February 90 low, crude oil has broken out from its wedge.

[REITs]

See 2017 Hedge Fund Letters.

Bullish Energy Sector & Bearish Financial Sector

This is good news for US energy sector investment grade credit. The move up in oil corresponds with an expected 20bps contraction in spreads to around 100bps.

Bullish Energy Sector & Bearish Financial Sector

If US energy investment grade spreads retreat to 100bps based on oil prices, it is possible we could see a 15% move higher in energy shares.

Bullish Energy Sector & Bearish Financial Sector

At the same time, the LIBOR-OIS spread is widening, which is a leading indicator for a widening in US financial sector investment grade credit spreads. At current LIBOR-OIS levels, financials spreads should widen by roughly 15bps. If funding pressures continue to push the LIBOR-OIS spread higher, financial spreads will possibly widen even more.

Bullish Energy Sector & Bearish Financial Sector

Widening financial credit spreads are a leading indicator for the performance of S&P 500 financial stocks. The widening already experienced could correspond to a 10% correction in the financial sector.

Bullish Energy Sector & Bearish Financial Sector

Distilled, this is a basic pairs trade long energy and short financials.

Bullish Energy Sector & Bearish Financial Sector

Article by by Steven Vannelli, CFA – Knowledge Leaders Capital

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