Every year, there are January surprises.
These occur when investors receive a pop in selected stocks because of the way fund managers behave in December.
It comes down to the need for managers to readjust holdings
as the fourth quarter concludes, usually to dress up performance indicators.
Now these improvements don’t usually last very long. Most investors see the affected stocks declining back to normal levels in mid- to late-January. But for a few weeks, there is a nice little return from a device hedge fund managers use at the end of each year.
This will be of interest to energy sector investors this time around. Last year, it was different. Back then, oil-related stocks were moving in one direction while natural gas stocks were moving in another. Service companies were beginning to come off of highs, and King Coal was about to fall off its cliff.
This time around, we have a fiscal cliff soap opera in the U.S., continuing credit concerns in Europe (although with a parallel rise in market optimism emerging on the continent), rising uncertainty again in the Middle East, and a simmering dispute between Japan and China.
In short, there is no lack of concern in the market, even ignoring those Mayans and their approaching December 21 deadline.
Still, there will be many beneficiaries in the energy sector as hedge fund managers make their moves in the next few weeks. This is likely to happen in several categories of companies.
I would emphasize two segments that are currently on the rise.
In each case, the rise prompted by fund managers is not likely to last into February. However, in the case of these shares, we will see a rise resulting from market forces themselves. That means the extra pop from a January surprise is not likely to be followed by these shares plummeting.
The first category are oil refineries having a diversified regional impact and sufficient refining capacity to address both light (high octane gasoline and early processing cuts like naptha and liquid petroleum gas) and middle (diesel, high-end kerosene – actually jet fuel, and low sulfur content heating oil) distillates.
Now refineries have been performing quite well even without the help of the fund managers. As my subscribers to Energy Advantage well know, companies like Valero Energy (NYSE: VLO) and Western Refining (NYSE: WNR) have been doing quite nicely over the past six weeks. Both VLO and WNR have been adding strength to the EA Portfolio and are prime candidates for January surprise material.
The second category is not one I would have selected a few months ago. But certain coal sector stocks have attracted the attention of the funds due to an upward pressure on share value this month. Two primary stocks of interest here are Peabody Energy (NYSE: BTU) and Cliffs Natural Resources (NYSE: CLF).
BTU is up 11% and CLF up 13.7% since December 3.
Each stock hit its most recent low on that date after it traded considerably above that level earlier in the quarter. December 3 appears to have represented an initial strike point for interest from some fund managers in these shares, a move that has increased since then.
Both the refiners and coal producers mentioned are likely to improve in price through the first part of January.
However, by around January 15, the trajectories should change. Refiners like VLO and WNR will continue to appreciate, albeit at perhaps slower increments than over the past month. These shares, therefore, are better candidates for longer-term holds.
When it comes to the coal companies, prospects are a bit different. While the demand for metallurgical grade coal (the coal needed for the production of steel) will continue at current levels or slightly better, overall coal demand should begin to decline.
In past years, the onset of the winter months would suggest a continuing need for power and heating fuel. That may continue to be the case in certain regions of the U.S. where coal continues to be the main source of fuel. However, that is no longer the case across the board.
Now, the increasing reliance on natural gas as the fuel of choice for electricity and thermal generation will blunt the normal move to coal during the winter season.
Therefore, BTU and CLF appear to be good candidates for sale in January (when the somewhat artificial bump from the managers has worked its way through the market).
A basic suggestion on these two would be a lightening of half your position half way through January and selling the remainder by the end of the month.
An unusually cold January may prolong the upward bias for either stock a little longer, but it is not going to change the overall decline as the first quarter moves along.
Editor’s Note: If you want to know the full story on how the energy markets really work, and what stocks Kent is recommending right now as January 1 approaches, click here to see this eye-opening presentation.