Energy stocks have jumped out to an early lead in 2022. While the S&P 500 is down after two weeks of trading, the Energy sector has rallied to its highest level in almost 2 years.

You may know that Energy was the top performing sector in 2021. But that stat masks the fact that the entire performance for the year was achieved by the middle of June. The second half of the year was spent digesting the area near $400, a place that acted as support from 2016 to 2019.

With that level now acting as support once again, the sector could challenge its 2018 highs.

We can see a confirmation of the recent strength when we look at the sector on a relative basis. The ratio of Energy to the S&P 500 has broken a multi-year downtrend line and has surged above 0.10, a level that’s acted as resistance over the past 2 years.

Energy’s fate depends largely on the direction of oil prices. As it so happens, WTI Crude Oil is trying to move past a long-term resistance level, too. The area between $75 and $80 was trouble in 2006, then acted as support in 2011 and 2012, before again marking a top, that time in 2018. For much of the past year, we’ve been stuck there again:

On a shorter term basis, though, it looks like oil could be ready to move on. Prices are challenging the multi-year highs from last fall:

While U.S. Energy stocks are clearly pricing in higher oil, one group of stocks seems to point the other direction: Emerging Markets. Historically, EM has had a reliable positive correlation with oil. Emerging economies tend to be more cyclically oriented than their developed market counterparts, thus when oil prices rise (thanks to strong demand and healthy activity) Emerging Market stocks tend to do pretty well, too. But in 2021 the relationship faltered – EM declined while oil stair-stepped higher:

That could be cause for concern for those watching oil prices. Or perhaps not. Why? The reason for the divergence can be summed up in a single word: China. China makes up roughly one-third of the entire MSCI Emerging Market index, and Chinese tech stocks have been hammered amid a government regulatory crackdown. If you exclude China from the EM index, the divergence with oil prices vanishes:

Emerging Markets aren’t as bad as they seem.

Nothing in this post or on this site is intended as a recommendation or an offer to buy or sell securities. Posts on Means to a Trend are meant for informational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in posts. Please see my Disclosure page for more information.

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