(CNBC) Energy stocks have been summarily punished over the past year and a half. And it hasn’t been a minor selloff. Now that the Federal Reserve has begun the tightening process, it will likely further cloud the outlook for the sector. Why? Because energy prices won’t stabilize until we approach an equilibrium point at which energy supply meets energy demand. The Fed’s normalization process will likely lead to further gains in the dollar, and therefore more downside volatility in the prices of energy and energy stocks.
The S&P 500 energy index is down about 38 percent from its high in mid-2014 (not including dividends). Perhaps more stunning, the S&P 500 energy index now comprises just 6.6 percent of the S&P 500 after peaking out at an intra-year high of over 16 percent in mid-2008.
Global economic growth is weak and may be getting weaker. China, the source of almost insatiable demand for energy and other commodities over the past couple of decades, is now experiencing a significant deceleration in economic growth. Nobody knows the true magnitude of the growth deceleration as Chinese economic data are notoriously unreliable. Some say China is now growing well below the government’s stated target of 7 percent. In any case, the uncertainty is causing a “shoot-first-ask-questions-later” mentality, and so prices across the commodity complex have plummeted in response.
But the economic weakness is not confined to China. Europe and Japan remain weak, and the emerging markets (except China) are suffering from massive capital outflows due to economic stagnation, overinvestment, falling currency values, and their heavy dependence on the commodity markets. Meanwhile, the variance in economic growth between the U.S. and the rest of the world is contributing to strength in the U.S. dollar, which further pressures commodity prices in the global marketplace.