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Investors have missed out on the big potential of energy stocks because of their solid, valuation-based fundamentals, experts say.
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Recent rallies in energy stocks are breaking key resistance levels since the 2022-2023 highs.
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Geopolitical risks and macroeconomic factors will fuel further growth for sector stocks.
Technology appears to be getting most of the attention in the stock market, but investors should turn to a less glitzy sector that is ripe for strong gains amid a cocktail of bullish tailwinds.
Energy stocks should receive more attention, market experts say, as the sector has started this year on an impressive winning streak, with the S&P 500 Energy Index delivering a return of 16.3% so far in 2024. However, top Wall Street economist David Rosenberg said investors are not yet taking advantage of the sector’s favorable market position.
“It is an overlooked part of the market as investor positioning is extremely negative (-$2.7 billion outflows from the SPDR energy sector ETF last year). This is a contrarian positive,” Rosenberg told Business Insider in an email Friday.
Market watchers say there are three key reasons why energy stocks will see further gains this year, with analysts expecting upside potential of up to 20% for the sector from current levels.
Strong fundamentals
Just as tech stocks soar on robust earnings, LPL Financial pointed in a note to the energy sector’s stellar earnings revisions, which outperformed all S&P 500 sectors in March – a timely reminder for investors as first-quarter earnings season begins .
“Favorable revisions coupled with higher oil prices are driving the sector significantly higher than estimates, in our view. Better capital allocation decisions by producers should help increase the chances that the sector’s gains will be well received by markets, even though the U.S. is strong.” “The U.S. dollar could pose a bit of a challenge in the near term,” Jeff Buchbinder and Colby wrote LPL Financial’s Hesson in a note this week.
Rosenberg said the recent rise in oil prices could mean better results for refiners and higher sales for exploration and production companies.
“A sustained upward trend [in prices] also means more capital spending in this sector, which translates into investments in storage, transport and equipment infrastructure, acting as a tailwind for these sub-sectors in the energy sector.”
As energy companies eye cash flow for higher dividends, buybacks and deleveraging, Buchbinder and Hesson predict rising sector valuations, consistent with Rosenberg’s forecast.
“Our strategist “The model’s valuation subcomponent for energy is at the 55th percentile on an absolute basis and at the 11th percentile relative to the S&P 500,” Rosenberg said.
The technical strength is high
Energy sector rallies are breaking key resistance levels since the 2022-2023 highs, with Buchbinder and Hesson saying the breakout was validated by bullish momentum and widespread buying pressure.
“Over 90% of stocks in the sector are now trading above their 200-day moving average, while almost half of the sector posted new 52-week highs earlier this month. Based on the size of the previous consolidation range, a technical minimum price “The target suggests approximately 20% further upside potential from current levels,” they wrote.
The seasonal prime time – April – also contributes to this strength, as energy consumption typically increases towards the summer driving season. With the S&P 500 energy sector index having an average return of over 3.7% and a 70% chance of positive returns based on historical data, Rosenberg said the momentum will continue through May.
“Although seasonality remains favorable, we believe it is the sector’s good risk/reward profile that will drive returns in the coming months. Our models, which focus on recommendations from a 12-month perspective, recently rated the energy sector screen as positive.” “We expect the momentum to continue,” he said.
Macro driver
As hostilities escalate in the Middle East and the conflict between Russia and Ukraine shows no signs of ending, such geopolitical uncertainties combined with OPEC+ production cuts will continue to drive oil demand and prices higher, LPL said.
Rosenberg agreed that would be another driver for energy stocks’ rise, but warned that a growth-driven decline in overall demand would pose the biggest risk to the sector.
Turning to monetary policy, Buchbinder and Hesson noted that the sector offers potential protection against stubborn inflation and longer-term higher interest rates.
They point out that energy is the only sector to have a positive correlation with 10-year Treasury yields, providing investors with a potential portfolio hedge against higher interest rates.
Read the original article on Business Insider