Volatile oil and gas prices, sudden price slumps, and concerns about future oil demand have combined over the past year or two to make investors shun oil and gas stocks, which have been ones of the worst performers as a sector in recent months.
Yet, despite the apparent Wall Street snub, Wall Street sell-side analysts and stocks experts are not convinced that the energy sector is done for good.
Some observers, like Andrew Bary for Barron’s, actually suggest that investors are missing out on the energy sector, and stocks such as Chevron for example could be a good play for the future. Despite an apparent case for lower oil and oil stocks prices amid fears of recession, the energy sector may be primed for a rebound, Bary argues.
The energy sector in the S&P 500 has gained a mere 0.9 percent year to date this year, while the S&P 500 Index has risen 16.6 percent, according to data up to August 19 from Standard & Poor’s compiled by Yardeni Research, Inc. The energy sector in the S&P 500 has been the worst performer among major industry sectors this year, outperformed by all major sectors such as consumer discretionary, consumer staples, financials, information technology, healthcare, industrials, materials, real estate, communications, and utilities.
Energy has been the least winning sector in the S&P 500 this year, and analysts say that it has also been the least loved by investors.
The energy sector is “one of the least preferred groups according to our latest client survey work, with oil and gas pricing being a key issue,” according to a recent research report from Citigroup’s U.S. equity strategist Tobias Levkovich, cited by Bloomberg.
Yet, according to the price targets of Wall Street analysts, the energy sector has the potential of posting the biggest gain over the next 12 months, data compiled by Bloomberg shows.
The 12-month expected return based on the price targets of sell-side analysts is 26.5 percent for the energy sector, followed by consumer discretionary and communications at distant 15.4 percent and 15.3 percent expected returns, respectively.
Some analysts argue that oil and gas stocks have undeservedly suffered more than other industry sectors and slide more than oil and natural gas prices when commodity prices start to fall.
“To even the most casual market observer, it should be blatantly obvious that the energy sector is broken,” Eric Nuttall, Partner, Senior Portfolio Manager at Ninepoint Partners, said in a market view report in early August.
Oil and gas stocks have barely moved up when oil prices have rallied this year. On the other hand, when oil is sold off on macroeconomic news, energy shares slump more than oil prices, according to Nuttall.
“The agonizing combination of limited upside participation with extreme downside capture has been soul crushing,” he said.
Nuttall sees three major factors that have battered oil and gas stocks in recent months and years. One is that energy companies have taken on a lot of debt to grow for ‘growth’s sake’, leaving investors with the perception that they are poor managers of capital and even poorer payers of returns. The other factors are U.S. shale that has changed the perception of the marginal cost of supply, with breakevens cited at below US$40 a barrel, as well as an environmental campaign drive of funds, fund managers, and banks to sell off oil and gas stocks.
According to Nuttall, two major events could reverse the market perception of oil stocks. One is faltering shale growth rates, which would end the sub-$40 breakeven and U.S. energy independence narrative. The other is energy companies showing competitive cross-industry returns on capital investment and a push against misinformation in the oil industry.
Citi’s Levkovich tells Bloomberg that a weaker U.S. dollar could help the commodities sector, and thus, energy stocks. Yet, market participants would want more signs of sustainable capex and return trends—which most in the U.S. shale industry are not good at. An increased appetite for cyclical stocks and improved capex could be a catalyst for investors returning to energy stocks again, Levkovich says, but notes that he doesn’t expect such improvement in the next few months.
Still, it could be the underperformance of energy stocks so far that could be a reason for investors to buy into some of the major oil companies, which generally have handsome dividend yields.
By Tsvetana Paraskova for Oilprice.com
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