Driven by the artificial intelligence (AI) craze, technology stocks seem to have attracted all the attention of U.S. stock investors, but some analysts believe that investors should focus on a less dazzling industry. Driven by various bullish factors, The industry is ripe for strong gains.
Energy stocks deserve more attention as the sector starts the year off with an impressive performance, according to top U.S. economist David Rosenberg, president of Rosenberg Research profound. The S&P 500 Energy index has returned 16.3% so far this year, and investors haven’t noticed yet.
“This is an overlooked segment of the market because investors have very negative positions (in the sector) (SPDR Energy ETF outflows of $2.7 billion over the past year),” he said.
Overall, there are three main reasons why energy stocks are expected to rise further this year, with some analysts predicting the sector will rise as much as 20% from current levels.
Strong fundamentals
Even as technology stocks move higher on strong earnings, LPL Financial noted in a report that the energy sector posted more March earnings revisions than all S&P 500 sectors, a timely reminder for investors as The first-quarter earnings season is about to begin.
“In our view, upward revisions, consistent with rising oil prices, keep expectations for the sector steadily rising,” LPL Financial’s Jeff Buchbinder and Colby Hesson wrote in a note. “Better capital allocation decisions by producers, should help increase performance in the energy sector, although a strong dollar may pose some short-term challenges.”
Rosenberg said the recent rise in oil prices could mean better performance for refiners and higher sales for exploration and production companies.
“Continued increases (in prices) also mean increased capital spending in the industry, which translates into investment in storage, transportation and equipment infrastructure, becoming a driving force for these sub-sectors in the energy sector,” he said.
As energy companies look to cash flow for more dividends, buybacks and debt reduction, Buchbinder and Hesson expect sector valuations to rise, in line with Rosenberg’s forecast.
Technical aspect
The rally in energy stocks is breaking through key resistance at the 2022-2023 highs, and Buchbinder and Hesson said bullish momentum and broad buying pressure confirmed the breakout.
“More than 90% of industry stocks are currently trading above their 200-day moving averages, and nearly half set new 52-week highs earlier this month. Based on the span of the previous consolidation range, the lowest price is based on technical considerations Targeting further gains of around 20% from current levels.”
April is seasonal prime time, as energy consumption typically spikes during the summer driving season. Based on historical data, the S&P 500 Energy Index has averaged returns of more than 3.7%, with a 70% chance of positive returns, and Rosenberg said the momentum will continue into May.
“While seasonality remains favorable, we believe the risk/reward profile of the sector will drive returns in the coming months. Our models focus on making recommendations from a 12-month perspective and have recently found the energy sector to be very attractive . So, we think this momentum will continue,” he said.
Macro situation
LPL said that as conflict actions in the Middle East escalate and the conflict between Russia and Ukraine shows no signs of ending, this geopolitical uncertainty coupled with OPEC+ production cuts will continue to push up oil demand and prices.
Rosenberg agreed that this would be another driver for energy stocks higher, but warned that a drop in aggregate demand tied to economic growth would pose the biggest risk to the industry.
On the monetary policy front, Buchbinder and Hesson noted the sector’s potential protection against sticky inflation and long-term high interest rates.
They note that energy is the only sector that has a positive correlation with the 10-year Treasury yield, providing investors with a potential portfolio hedge against rising interest rates.
