Heartbreaking market volatility and attractive valuations are prompting some investors to keep their optimistic views on energy stocks, one of the few bets that have thrived in an otherwise tough year.
It’s not an easy call. The energy sector of the S&P 500 is already up around 46% this year, and tightening monetary policy around the world has increased the chances of a global recession that could choke energy demand.
Still, signs that supply will remain comparatively tight are causing some investors to hold onto the sector, lured by attractive earnings prospects and valuations that remain comparatively low this year despite big gains for many energy stocks. The energy sector of the S&P 500 trades at a trailing price-to-earnings ratio of 9.9, nearly half the broader index’s 17.4 valuation.
Few see an end to the sell-off in broader markets either, as stubborn inflation fuels expectations of further market-punishing rate hikes from the Federal Reserve and other central banks. The S&P 500 is down about 24.5% this year, while bonds — as measured by the Vanguard Total Bond Market index fund — are down nearly 18%.
“It’s hard to imagine people giving up energy because it’s the best of both worlds,” said Jack Janasiewicz, portfolio manager at Natixis Investment Managers Solutions, citing the sector’s low valuation and the potential for more gains if the offering stays tense. “If you’re worried about the direction of the market, this is a great place to hide.”
Analysts are expecting earnings per share for energy companies to grow 121% in the third quarter from the year-ago period, while the broader ex-energy index is down 2.6%, data from Refinitiv showed.
Energy is the only sector in the S&P 500 that analysts at Credit Suisse expect to revise their third-quarter earnings upside. US oil giants Exxon Mobile Corp. XOM.N and Chevron Corp. CVX.N report earnings on October 28th.
In the coming week, investors will focus on gains from Tesla Inc. TSLA.O, Netflix NFLX.O and Johnson & Johnson JNJ.N, among others.
Expectations for further tightening in the oil market have been bolstered by recent OPEC+ production cuts as well as plans by the European Union to phase out Russian crude by February.
US production is expected to average 11.75 million bpd in 2022, up from a previous estimate of 11.79 million bpd, according to the US Department of Energy.
Brent crude oil prices came in at $91.46 a barrel on Friday, up nearly 10% from a recent low, after falling nearly a third between July and September.
“There is an outsized possibility that crude oil prices will continue to rise, especially if demand concerns don’t materialize to the extent some bears are expecting,” wrote analysts at TD Securities, who expect oil prices to hit $101 in 2023. Analysts at UBS Global Wealth Management expect oil prices to hit $110 by year-end.
Some fund managers remain skeptical that the energy sector can continue to outperform as the global economy slows amid central bank tightening.
“We’re heading into a recession globally and that’s going to hurt the demand side,” said Burns McKinney, portfolio manager at NFJ Investment Group, which is increasing its overweight exposure to dividend-paying technology companies like Texas Instruments TXN.O and Cisco CSCO.O.
At the same time, the sell-off in the S&P 500 creates buying opportunities in consumer discretionary and large-cap tech stocks, which are more attractive over the long term than energy, said Lamar Villere, portfolio manager at Villere & Co.
“We’re starting to see opportunities that are harder to take advantage of,” he said.
However, others believe the fundamentals for the sector remain aligned and see more upside. Saira Malik, Nuveen’s chief investment officer, believes fund managers will remain lightly positioned despite recent gains in energy stocks. She is also betting that China’s economy will recover in the coming months, which will support global oil prices
“We still think energy has legs here,” she said.
Source: Reuters (reported by David Randall; edited by Ira Iosebashvili, Mark Porter and David Gregorio)