Bearish Markets: A Self-Fulfilling Prophecy

In my early days of trading, I had a ‘mentor’ of sorts who gave me all sorts of advice and useful tips about market action. One I remember clearly was him saying this:

“In a bullish market, all news is bullish. In a bearish one, everything will drive the market lower”.

Boy, this week proved again how incredibly right he was about that.

We’ve just had a week of the most pessimistic reaction to what should have been very bullish news for oil. Instead, we’ve seen those bullish fundamentals rewritten as bearish indicators – and watched as oil and oil stocks have sunk lower.

For example, OPEC and Russia came to a historic alliance to control supply for the next 9 months, yet the reaction was muffled. “Couldn’t they have done more?” many analysts mumbled, and the markets dropped.

As unpopular as it seemed, at least the pulling out of the Paris Climate agreement would have a positive impact on energy prices, right? No. Analysts concluded that oil companies could be hurt by the revitalization of coal – and markets tanked.

When we had two massive unexpected drops in U.S. stockpiles, they lead not to a gain in oil prices, but a surprising small loss; while yesterday’s unexpected build in stockpiles was met with a complete ROUT of oil and oil stocks.

First, Morgan Stanley and Goldman Sachs’s bearish fear was that global supply and demand wouldn’t re-balance in 2017. Now that they seem to have been wrong about that fear, it has instead reasserted itself as a bearish fear that shale production will increase another 1 million barrels a day in 2018 and lead to a resurgent glut just as the OPEC production deal is rolling off.

It doesn’t matter whether much of what’s happening in the oil markets this week is nothing but a case of perception – and misperception. When markets are trending, and the participants are all thinking the same way, you cannot fight the force. In the last two weeks, there’s been nothing but pessimism floating around oil.

And has punished the oil markets and oil investors.

Of course, fundamentals always win in the end. But another piece of old wisdom I learned early on applies here; “Markets can be irrational longer than you can remain solvent”.

Recent case in point: Throughout 2013 and 2014, we saw the oversupply of more than a million barrels a day in the market adding inexorably to global stockpiles. Analysts then trotted out convoluted explanations describing this glut building as perfectly normal and even bullish for prices.

Ultimately, these fundamentals exerted themselves and oil dropped from over $100 a barrel to under $30.

Let’s look at today: Is the oil supply contracting? Yes. Is global production rolling over and here in the U.S. in two of three major U.S. shale plays? Check. Has the OPEC deal to remove 1.6m b/d held with unprecedented compliance? You bet. Are capex budgets still in collapse, making replacement of spent wells expensive, if not impossible? Check, check and check.

All of this should ultimately lead to a wildly bullish move in oil. But just as in 2013, we can’t just buy stocks randomly and hope that the markets become less irrational on our own schedule.

Now is a time to sit back and wait for the inevitable turnaround. We can always get aggressive on the way up.