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Energy Sector Rating: Marketperform

By

Brad Sorensen

photo
CFA, Managing Director of Market & Sector Analysis, Schwab Center for Financial Research

Brad Sorensen heads market and sector analysis for the Schwab Center for Financial Research and writes for several Schwab publications. He is a member of Schwab's Investment Strategy Council.

Before joining Schwab in 2004, he was a senior analyst at AMG Guaranty Trust, where he designed portfolio strategies for high-net-worth individuals. Sorensen graduated from the University of Colorado with a bachelor's degree in finance and master's degrees in business administration and finance. He is a Chartered Financial Analyst charterholder.

October 25, 2018

Member for

1 year 9 months
Submitted by satya.billa on Thu, 10/25/2018 - 09:00
Energy Sector

Energy sector overview

Global growth worries have appeared to weigh on the energy sector. Geopolitical events are unpredictable and often impact the energy sector, which should be taken into account along with the fundamentals of the group.

Market outlook for the energy sector

The energy sector has had a rough month, being the worst performing sector in the S&P 500 over that period.  Global growth worries as well as supply reassurances from Saudi Arabia appear to us to be the major contributing factors toward that underperformance.  But with sanctions officially reimposed on Iran, and geopolitical risk existing, we are hesitant to go underweight at this point as we’ve seen sharp rebounds over the past year that we believe could happen again.  Additionally, the energy sector tends to be a better performer later in the business cycle, which is where we believe we are—so we are keeping our marketperform rating on the group…for now.

Taking a little larger view, the energy sector’s performance has been volatile this year, with investors attempting to balance a U.S. demand that allies stop using Iranian oil, trade friction, and both inventory and supply concerns. These crosscurrents keep us at marketperform for the group as mentioned as we don’t know where the balancing point is for the price of oil, but believe we may be close to it. Additionally, American oil production continues to move higher, according to the Energy Information Agency, causing a bit more concern among investors. This illustrates why we’re still concerned that the discipline shown on the supply side both with OPEC and here in the U.S. won’t last as companies and countries chase profits. Additionally, according to Baker Hughes, the rig count in the U.S. has started to move higher again after a brief dip.

We admit to being more cautious than others recently with regard to the energy sector, due largely to the potential risks of a sharp turnaround—much as we’ve seen in the past—but we aren’t opposed to those with higher risk tolerances looking to be modestly overweight in energy, understanding that reversals are quite possible, such as we’ve seen over the past month. Despite our caution, there remain bullish developments and should discipline among producers continue to hold—both domestically and globally, we would consider upgrading the group. Additionally, global growth concerns could dampen the price as trade concerns rise, and could affect global activity. But at this point we don’t think growth will deteriorate to the point of producing a reduction in the need for oil, keeping us in the marketperform camp—for now.

It is often said that the cure for high energy prices is high energy prices and we could have gotten close to that point, leading to our continued hesitation to raise the overall weighting on the group. So, for now, we believe the factors outlined above support a rating of marketperform.

Factors that may affect the energy sector

Positive factors for the energy sector include:

  • Potential increase in energy demand: The U.S. economy is growing, and developing nations will likely need more energy as they improve their infrastructure and modernize their economies.
  • Accommodative monetary policy: Central banks in the developed world, with the notable exception of the U.S. Fed, generally appear to have an easing bias, which could help the more cyclical sectors such as energy.
  • Rising geopolitical tensions: These tensions, if raised, could result in higher oil prices.

Negative factors for the energy sector include:

  • New supply: Energy supply has increased dramatically with a renewed commitment to exploration and technological improvements.
  • Increased conservation: Conservation efforts and new technology could affect the growth in demand for energy products.
  • Energy use restrictions: Severe pollution problems in China could result in mandates to cut energy use

 

Clients can see our top-rated stocks in the energy sector.

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