It was less than 24 hours after we posted that either oil will double from here allowing energy companies to grow into a normal P/E multiple, or energy stocks will have to crash by over 40% for the ridiculous 23x to return to its normal, long-term average of 13.6x. Moments ago energy giant Chevron admitted that not only does it not see oil doubling any time soon, but that energy prices are almost certain to go far lower from here, and as a result the company decided that after buying back $5 billion of its shares in 2014, i.e., buying high and higher before the stock crashes may not be the best use of dwindling cash flow, and as a result has just suspended its stock buyback program of the rest of 2015. Yes, energy giant Chevron just ended its buyback!
As regular readers know, company buybacks are forecast to be the single biggest source of demand for stocks in 2015..
... which means this may well be the beginning of the end of the 6 year bull market. For now, the realization if only hitting Cheveron stockholders.
Also did we mention Chevron's "dwindling cash flow"? Good: here's why:
- DRILLING RIG RATES HAVE FALLEN AS MUCH AS 50%: CHEVRON CEO
- CHEVRON SAYS DROP IN GLOBAL OIL PRICES SQUEEZE CASH FLOW
It's not just buybacks that are out of the window. So is CapEx..
- CHEVRON SIGNIFICANTLY REDUCING EXPLORATION, DESIGN SPENDING
- THIS YEAR'S CAPEX CUTS WILL IMPACT OIL OUTPUT POST-2017: CVX
... and SG&A:
- CHEVRON REVIEWING STAFF LEVELS AROUND THE WORLD, CEO SAYS
Finally, all those who are so sure a surge in oil prices and energy stocks is just around the corner, here is a little more cold water:
- WORLD ENERGY DEMAND FAIRLY MATCHES WORLD ECONOMIC GROWTH
- CVX DOESN'T SEE MUCH CHANGE IN WORLD ENERGY DEMAND ON GROWTH
But the financial comedy TeeVee said it was all an "excess-OPEC supply" problem?
* * *
And for everyone who missed it yesterday, here again is "Either Oil Soars Back To $88, Or Energy Stocks Have To Tumble By Over 40%"
Several days ago we showed something remarkable: "current forward 12-month P/E ratio for the Energy sector is now well above the three most recent historical averages: 5-year (12.0), 10-year (11.9), and 15-year (13.6). In fact, this week marked the first time the forward 12-month P/E for the Energy sector has been equal to (or above) 22.4 since April 8, 2002. On that date, the closing price of the Energy sector was 225.15 and the forward 12-month EPS estimate was $10.05."
Further refining this analysis and using the S&P Energy Sector Index data, the sector's forward multiple is now an absolutely ridiculous, mindblowing 23x, the highest since 2002, having soared by nearly 100% in just the past few months as a result of collapsing energy sector earnings.
How is this possible?
Simple: as the chart below shows, since the oil's peak in June 2014, Energy company EPS have crashed by 50%, as a result of a 60% plunge in the price of oil. What about Energy Index prices? Well, they have fallen to be sure, but nowhere near far enough to where they should, down "only" 20% from the highs.
So what does this mean? Simple: either the long-term PE multiple is now null and void, and the "New Normal" forward PE of 20X+ is realistic, which of course is ridiculous, or there are two alternatives:
- Energy sector earnings have to surge by 70%, implying a near doubling of oil prices to $88, for the forward P/E multiple to return to normal, or
- The Energy sector price has to crash from 549 today to 323, where it would trade down to its historic forward P/E multiple, suggesting a price drop of over 40%!
This is shown visually on the table below:
So which is it? Well, as the following chart showing a relationship we have grown to love over the past few months, the main reason why energy stocks are loathe to catch down to reality is the same BTFD mentality which is keeping the S&P elevated well over 100% above its fair "ex-central banker" value. Indeed, every single time even the smallest buying momentum arrives, energy stocks soar as if stung, only to recrash day after precisely to where credit says they should be trading.
Which means that once the ongoing euphoria of a 5 year Pavlovian BTFD reaction wears off, the pain for those long energy equities (and credit, since the above analysis implies energy credits are also massively mispriced) will be unprecedented, unless of course, by some miracle, oil does indeed double from here and on very short notice.
But wait, it gets worse, because while equities are pricing in an unsustainable 23x in foward energy P/E, another market, that of interest rate forwards, is implying oil plunging down to $35! As a reminder, oil is among other things, a function of rate differentials or said simpler, USD strength, strength which appears is not going anywhere. And as the following calculation from Cornerstone implies, should the EURUSD tumble to parity which is what Draghi's desire seems to be, it would suggest a 22% plunge in oil from here, implying a $35.5 price of oil one year from now.
This in turn would mean that, all else equal, the forward PE multiple would rise to just shy of 30x, and/or that Energy prices as a group would have to tumble over 50% from current levels!
Of course, if and when energy prices are cut in half, this would also have devastating consequences on the rest of the S&P, and all other asset classes, and almost assuredly force the Fed to not only forget all about hiking rates, but promptly engage in QE4.
Which may be just what the market is pricing in.
The only problem is that one can't have a world in which both QE4 is priced in (as equities are doing), as well as pricing in the 2015 Fed rate hike (as oil is doing), and is one of the main drivers of the USD strength.
One has to give, and it has to give soon.