Stock market crashes can be brutal for investors. Share prices seem to fall off a cliff, with no bottom in sight. While no stocks are immune to these events, some stock market sectors hold up better than others.
Following the leader
The energy industry is cyclical. Energy demand tends to rise when the economy expands, causing the price of energy commodities, like oil and gas, to rise. Those higher prices incentivize energy producers to invest in increasing their production by drilling more wells so that supply can keep up with demand.
However, economic expansions don’t last forever. The economy eventually backtracks, going into recession. That often triggers a stock market correction, sending shares of most economically sensitive companies tumbling.
The energy sector isn’t immune to these downturns because when the economy stalls, its demand for energy declines. This causes commodity prices and energy stocks to go into a free fall.
That’s evident in the following chart. The gray bars show the last three recessions. In each case, the price of oil, the S&P 500, and energy stocks declined in a relatively similar fashion. Further, the declines in energy stocks are often even deeper than the overall drop in the S&P 500. For example, in last year’s pandemic-inspired market crash, energy stocks tumbled nearly 60% compared to a roughly 30% plunge in the S&P 500:
That devastating decline in oil prices hit some oil companies so hard that they had to file for bankruptcy, leaving their shareholders empty-handed.
Going off script
While there’s a lot of correlation between the broader economy and the energy market, it’s not always perfect because the energy cycle can be shorter than the overall economic cycle. If supply outpaces demand, oil prices can sell off, taking energy stocks down with them, even during an economic expansion and bull market in stocks:
That was the case in 2015 and 2016, when oil prices and energy stocks crashed even though the stock market and economy kept humming along. The culprit, in this case, was surging supplies from the U.S. due to a focus on growing production at all costs from American oil companies. That strategy saw U.S. oil output surge to the point where it was grabbing market share from global leaders Russia and Saudi Arabia:
That caused the Saudi-led OPEC to fight back by flooding the market with oil, causing crude prices to crash, taking energy stocks down with it. This oil market crash also caused a wave of industry bankruptcies, as many oil companies couldn’t stay afloat. On the other hand, that decline in oil prices likely helped the broader economy by providing cheaper crude oil, giving the stock market more fuel to keep rising.
If you’re looking for safety, look elsewhere
The energy industry is very cyclical. Because of that, energy stocks will most assuredly decline during a deep economic recession, the typical catalyst for a stock market crash. As a result, they’re not safe stocks to hold during a crash because they often experience even deeper declines than the broader stock market.