If you’ve watched the news at all during the past half-year period, you know that the oil industry has been one of the worst hit during this novel coronavirus pandemic. Naturally, conservative investors should adopt a careful approach to sector players like Marathon Oil (NYSE:MRO). Really, the issue isn’t so much MRO stock but rather the underlying market.
However, not all oil stocks are the same. Case in point is my recent write-up on Whiting Petroleum (NYSE:WLL). Here, I focused mostly on the technical arguments as there’s not much to be said about the fundamentals that haven’t already been covered. To quickly recap, the oil market is recovering, which is positive for a name like MRO stock.
But demand remains substantially mitigated, which means something must change to move the needle of credibility. I will argue that should you believe in the broader recovery narrative and are also risk-tolerant, you could consider MRO stock. In order to establish this logic, though, we should appreciate that Marathon isn’t Whiting Petroleum.
Specifically, WLL stock shares no statistically significant relationship with the underlying oil market (West Texas Intermediate). Since April of this year, WLL and oil prices have a correlation coefficient of less than 35%. Typically, the cutoff for statistically significant relationships is at 40% (or -40% for inverse correlations).
That’s a far cry from the period between 2003 until the end of 2019, when WLL had an 80% correlation coefficient with oil prices. In my view, we saw a shift from rational market to an irrational one as it relates to Whiting. Put another way, just because oil prices improved doesn’t mean we should necessarily expect the same for WLL.
A Different Setup for MRO Stock
Again, I should caution readers that just because other oil investments are terrible doesn’t automatically grant MRO stock upside. However, if you’re going to take a shot at a speculative market, you want to improve your odds as much as possible.
Certainly, on a technical level, you’ll want to make sure that your target trade is aligned with a reliable benchmark. That way, when you anticipate changes in the benchmark, you can adjust your trading tactics or strategies accordingly.
For WLL, this system doesn’t work because shares have disconnected from the oil market. But from the get-go, you see the immediate difference with MRO stock.
From 1986 to end of 2019, MRO and oil prices shared a 92.9% correlation coefficient. That’s about as correlated as you can get before you start to question whether the two data points are identical. Of course, Marathon also experienced some disconnect as well because of this crisis. Since the start of this year, the coefficient has dropped to 73.4%.
However, two points are relevant here. First, since May, the coefficient is holding strong at nearly 62%. I calculated the same for WLL and oil prices and it returned a completely meaningless 9.1%.
Second, you may be able to make the argument that MRO stock is undervalued relative to oil prices. This year, the peak-to-trough difference for the West Texas Intermediate index is 152%. For MRO, it’s 84%. Theoretically, Marathon has room to run.
I must say, WLL would be considered more undervalued using this exercise. However, most investors would have confidence in Marathon Oil because its stock still maintains a strong correlation with the underlying oil market. And that’s especially the case when stacked up against WLL.
Gambling on a Recovery
While the technical narrative is appealing for MRO stock, at the end of the day, the fundamentals will win out. For Marathon to transition from a pure speculative gamble to a worthy discounted investment, we need to see credible evidence of a broader economic recovery.
On one hand, we’re seeing encouraging headline numbers. For instance, the unemployment rate dipped in July, which took me pleasantly by surprise. Additionally, initial weekly jobless claims fell below one million for the first time since this crisis. If we keep this up, we could get that meaningful recovery in oil demand as people return to work.
But on the other end, permanent job losses have spiked uncomfortably high. This sad tally could rise higher because several small businesses could close their doors permanently. Because small businesses represent the engine of the labor market, it’s clear we’re still not out of the woods.
It really comes down to what you believe. As a speculative shot, you may have a decent chance of profitability with Marathon Oil. Longer term, though, I’m hesitant.
A former senior business analyst for Sony Electronics, Josh Enomoto has helped broker major contracts with Fortune Global 500 companies. Over the past several years, he has delivered unique, critical insights for the investment markets, as well as various other industries including legal, construction management, and healthcare. As of this writing, he did not hold a position in any of the aforementioned securities.