Energy stocks have lagged the S&P 500 for the past year and the past decade. But that story could change in the years ahead. And for one analyst, energy is his “trade of the decade.”
“What energy had been missing is a catalyst,” said David Mazza, managing director and head of product at Direxion, a mutual fund and ETF manager. “Certainly, the news that we heard on Friday [that the U.S. had killed Iranian General Qassem Suleimani] is a sign that we need to maybe have a higher geopolitical risk premium placed in the oil markets.”
Those kinds of risks have arisen before, most notably in September, when drones attacked a Saudi Aramco oil processing facility. The attack triggered a nearly 15% one-day spike in WTI (CL=F), but it wasn’t sustained, and oil quickly fell back below $60 a barrel. Mazza points out that if investors do buy energy stocks for the long term, they have to be prepared for volatility that echoes swings in the commodity.
Separately from the price action in the oil market, Mazza said there are cyclical factors that could benefit the energy sector. Many energy companies, particularly small- and mid-caps, invested heavily in the shale revolution and got over-leveraged, resulting in poor credit quality and bankruptcies.
“As some companies actually begin to go through their bankruptcy cycle, and get a bit healthier, the overall market will continue to be able to generate revenue and cash flow that was needed,” Mazza said. “So there is the potential for the short term to be volatile.”
Ironically, he also points to big oil’s exposure to alternative energy.
“Exxon (XOM) is a great example of this, they've been investing a significant amount of capital to help diversify their business, and not just be a one trick pony when it comes to oil,” Mazza said.
Another source of demand, or at least support, for energy stocks has been the relatively high dividend yield. Paul Schatz, President of Heritage Capital, told Yahoo Finance’s On the Move that Schlumberger (SLB) is one of his top stock picks for 2020 -- a selection he made before the recent rearing of U.S.-Iran tensions.
“I thought, crude is going to have a decent year. If crude’s good, look for leveraged plays. Schlumberger, huge international oil driller. They’re paying a 5% dividend yield to wait, even if you’re wrong,” he said.
Energy stocks in the S&P 500 have a dividend yield of about 3.8%, compared to 1.8% for the broader index. Schlumberger yields nearly 5%.
The S&P 500 Energy Index rose 7.6% in 2019, lagging the next-worst performer — health care — by more than ten percentage points. For the last decade, it gained a measly 6.2%, compared with 190% for the S&P 500. Even accounting for the sector’s relatively rich dividend yield, its total return in the 2010s was 36%.
“If you're looking for one area that's been completely out of favor, fund managers have forgotten about it. It really is the energy space,” Mazza said.
Julie Hyman is the co-anchor of On the Move on Yahoo Finance.