“While oil prices have surged this year on the back of geopolitical concerns, the performance of energy stocks has far outpaced the underlying commodity.

The deviation between energy and the price of oil is at very dangerous levels.  Valuations in this sector are also grossly extended from long term norms.

If oil prices break below the consolidation channel OR a more severe correction in the markets occurs, the overweighting of energy in portfolios could lead to excessive capital destruction.

While the argument has been primarily focused on the ‘yield chase,’ the ‘price destruction’ will far outweigh the desire for income.  It is a good time to take profits in the sector and reweight portfolios back to target goals.”

As oil prices took out the long term trend line, the expected reversion in equity prices also began.

There is no doubt that the current selloff in oil prices has gotten extreme. However, what is interesting is that such price declines in oil prices have often been associated with rather sharp economic slowdowns or recessions. Currently, economists are expecting robust economic growth going into 2015 and suggesting that falling oil prices will boost consumption. However, as I discussed recently, there is very little evidence to support that claim.

“Personal Consumption Expenditure (PCE) number that comprises roughly 2/3rds of the economic GDP calculation. Therefore, we can also analyze falling gasoline prices as it relates to total PCE. Again, falling gas prices should lead to increases in PCE.”

“While the argument that declines in energy and gasoline prices should lead to stronger consumption sounds logical, the data suggests that this is not actually the case. With consumers heavily leveraged already, any increases in disposable incomes from lower gasoline prices are likely negligible in terms of their monthly spending.”

The purpose of today’s post is to give you a series of charts to analyze the current decline in oil prices and provide some clarity on the expected impact to both the energy sector and the economy as a whole.