One is the Loneliest Number
Energy is the only sector in the S&P 500 that’s positive over 3-month, 6-month, and year-to-date periods. If we take that window back one year, the only other sectors with positive returns are Utilities, Consumer Staples, and Health Care — the classically “defensive” portions of the index. And even still, Energy has outperformed all three of those sectors by more than 43 percentage points. Yowza.
In this bear market, Energy truly is the last man standing. Perhaps rightfully so given the supply/demand relationship that drives prices and the chain of events that has affected both sides of that equation. But it begs the question: will Energy meet its “mean reversion” fate too?
Another One Bites the Dust
It’s already on its way. The Energy sector has fallen almost 20% since its most recent high on June 8th, with WTI Crude Oil prices down 16% and Natural Gas down 22% over the same period. That puts Energy very near bear market territory and Natural Gas squarely in one. And that all happened over the last 14 calendar days!
The tricky part about this is that Energy stocks don’t necessarily follow Energy prices. And even with the recent fall, oil prices are still ~60% higher than they were pre-pandemic, which has given a boost to Energy companies who make a profit off of rising prices. In fact, Energy may be one of the only sectors still set to raise earnings guidance for the rest of the year given the persistently high demand and elevated price of oil.
Hence the popular call to buy or hold energy stocks. Despite the S&P 500 market cap now being back to where it was one year ago, the market cap of the Energy sector has more than doubled.
Juice Ain’t Worth the Squeeze
But this isn’t a popularity contest and I wasn’t prom queen. Trends and momentum work until they don’t, and in the case of energy prices, inflection points can look like blunt force trauma on a chart. Given the current global slowdown, increasing fear of recession with demand destruction, and the possibility of a surprise de-escalation in Russia/Ukraine, I don’t see this as a good time to rely on high oil prices as a buy signal. I see it as a good time to take profits.
The devil’s advocate argument is one I already made — that energy stock prices don’t necessarily follow energy commodity prices — but they’re related enough for me to feel like the chance of disappointment over the next 12 months is higher than the chance of positive surprises. The one caveat I would make is that if you are an investor looking for dividend income, energy stocks may be attractive. If price appreciation is your objective, it’s more important to lessen the blow of sharp drawdowns than it is to participate in the extra few percentage points of upside.
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