Schwab Sector Views: Trump Plus OPEC Equals …What for Energy?

Schwab Sector Views is our three- to six-month outlook for 11 stock sectors, which represent broad sectors of the economy. It is designed for investors looking for tactical ideas. We typically update our views every two weeks.

To some, it had been looking like the perfect storm was developing for the energy sector. The Organization of the Petroleum Exporting Countries (OPEC), which represents 13 major oil exporters, agreed in November to cut production by 1.2 million barrels per day (mbd). Meanwhile, a surprising win by President Donald Trump and a Republican takeover of Congress brought hopes of accelerated economic growth, a reduction in regulations, and in general a more-friendly environment for energy companies to operate in.

Energy did get an initial boost as investors looked at those possibilities and bought into the bullish narrative. Since the first of the year, however, the energy sector has been among the worst-performing groups in the S&P 500® index. What happened, and what should investors do?

In one word … reality! Sometimes that can be a real buzzkill! However, sentiment appears to us to have gone a bit too far the other way—as is typical with the energy sector as of late, it’s either “everything is great” or “the world is coming to an end”—we suggest a bit more measured outlook. Cutting through the noise, what’s really going on?

First, the OPEC cuts. As mentioned, the group agreed to cuts of 1.2 mbd on November 30, 2016, which represented about 4% of the daily output of those countries. But it came with a caveat that neither Nigeria nor Libya would be subject to production limitation. And there was an unspoken, but well-known, caveat: OPEC members are notorious for cheating on their quotas based on various historical news reports. At this point, however, it looks like they’re making pretty good progress toward the goals, as production from the group was about 900,000 barrels lower in January than it was before the agreement, according to Petro-Logistics, a consultancy that monitors global oil trade flows. The Saudi Arabian energy minister said his country has actually cut production to below their agreed-upon level of 10 mbd, according to Reuters.¹ These should be bullish developments,  and oil prices did bounce a bit in the wake of the agreement. However, we remain somewhat skeptical that the cuts will hold for long and, more importantly to us, the impact of these cuts are somewhat limited, in our view.

Oil prices bounced following November OPEC agreement

Source: FactSet, Dow Jones & Co. As of 2/6/2017.

The impact of the cuts also appears limited to us due to the resurgence of the oil shale industry in the United States. Hundreds of rigs were shuttered in the wake of the crash in oil prices in 2014, but they didn’t go away, and in many cases they are relatively easy to put back into service. And partially as a result of the crisis, operators drove down costs of doing business, so companies can now be profitable on much lower levels of crude. For example, the breakeven rate in both the Permian and Bakken oil fields is now below $40/barrel, down from over $60 in the former and over $80 in the latter, according to a Reuters article (citing data from Rystad Energy’s NASWellCube).² The result of this, in our opinion, is a lower top end on oil prices as more supply can be added at lower costs—and we’re seeing that come to fruition, as rigs in operation have rebounded and hiring has started again. According to the U.S. Bureau of Labor Statistics, 3,300 oil and gas extraction and service jobs were added in November 2016, the first increase since 2014.

Rigs are on the increase

Source: FactSet, Baker Hughes, Inc. As of Feb. 6, 2017.

As for the new mix in Washington, and President Trump in particular, we continue to believe that his administration will be more friendly to the energy industry than the previous one. In “An America First Energy Plan,” available on the White House website, the Trump administration says it plans to push for deregulation and more development and exploration of American natural resources. It also notes that it plans to do so in a way that considers environmental impacts, although there aren’t a lot of specifics at this point. Trump did fulfill his promise to try to get the Keystone and Dakota pipelines going again by signing an executive order. However, rolling back more regulations and getting an infrastructure spending plan through Congress is going to be more difficult and certainly take more time—throwing a bit of cold water on the initial enthusiasm surrounding the group.

And of course it’s not just the U.S. that we have to consider. China, a major consumer of oil, is coming off a solid growth year and has continued to report decent economic data: the Caixin China General Manufacturing PMI came in at 51 in January, remaining in expansionary territory, while the Caixin China General Services PMI number was a solid 53.1. But there are some concerns that the Chinese government may attempt to slow growth in 2017. They’ve expressed concern about the 19.9% growth in property prices in 2016 (according to Ned Davis Research) and China’s central bank already has raised the cost of loans under the medium term lending facility. And with the government apparently becoming more concerned with environmental issues, limitations have been imposed on motor vehicle use and manufacturing activity. Combined with a more restrictive fiscal policy, these curbs could mean decelerating growth in demand for energy products.

As you can see, the energy picture can be a complex one, due to the numerous players involved, but at this point we believe it all adds up to a group that performs roughly in line with the market. But performance likely won’t be in a straight line: We’ll likely continue to see sharp rallies and sizeable downturns, as we have over the past few months. We believe the prudent course of action for our investors is to remain patient and calm—consider adding to positions as needed on the dips, and paring back as needed on the rips.

Schwab Sector Views: Our current outlook

Sector

Schwab Sector View

Date of last change to Schwab Sector View

Share of the
S&P 500 Index

Year-to-date total return as of 02/07/2017

Consumer discretionary

Marketperform

07/17/2014

12%

3.44%

Consumer staples

Marketperform

05/07/2015

9%

2.82%

Energy

Marketperform

11/20/2014

7%

-5.10%

Financials

Outperform

05/07/2015

15%

1.34%

Health care

Outperform

01/26/2017

14%

3.83%

Industrials

Marketperform

01/29/2015

10%

2.01%

Information technology

Outperform

04/29/2010

21%

6.56%

Materials

Marketperform

01/31/2013

3%

3.77%

Real estate

Underperform

01/26/2017

3%

-0.28%

Telecom

Underperform

09/12/2013

3%

-4.75%

Utilities

Underperform

05/23/2013

3%

0.69%

S&P 500®  Index (Large Cap)

 

 

 

2.58%

Source: Schwab Center for Financial Research and Standard and Poor's as of 01/31/17.

Clients can use the Portfolio Checkup tool to help ascertain and manage sector allocations.

What is Schwab Sector Views?

Schwab Sector Views is our three- to six-month outlook for 11 stock market sectors, which are based on the 11 broad sectors of the economy.

The sectors we analyze are from the widely recognized Global Industry Classification Standard (GICS) groupings. After a review of risks and opportunities, we give each stock sector one of the following ratings:

  • Outperform: Likely to perform better than the rest of the market.
  • Underperform: Likely to perform worse than the rest of the market.
  • Marketperform: Likely to track the broad market.

How should I use Schwab Sector Views?

Investors should generally be well-diversified across all stock market sectors. You can use the Standard & Poor's 500 allocations to each sector, listed in the chart above, as a guideline.

Investors who want to make tactical shifts in their portfolio can use Schwab Sector Views' outperform, underperform and marketperform ratings as a resource. These ratings can be helpful in evaluating and monitoring the domestic equity portion of your portfolio.

Schwab Sector Views can also be useful in identifying stocks by sector for potential purchase or sale. When it's time to make adjustments, Schwab clients can use the Stock Screener or Mutual Fund Screener to help identify buy or sell candidates in particular sectors. Schwab Equity Ratings also can provide an objective and powerful approach for helping you select and monitor stocks. 

Next Steps

Talk to Us
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-          Call Schwab anytime at 877-338-0192.
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Important Disclosures

The Caixin China Report on General Manufacturing is based on data compiled from monthly replies to questionnaires sent to purchasing executives in over 500 manufacturing companies. The Caixin China General Services PMI™ is based on data compiled from monthly replies to questionnaires sent to purchasing executives in over 400 companies. An index reading above 50 indicates an overall increase in that variable, below 50 an overall decrease. Both indexes are published monthly by Markit IHS.

The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of Morgan Stanley Capital International Inc. (MSCI) and Standard & Poor's. GICS is a service mark of MSCI and S&P and has been licensed for use by Charles Schwab & Co., Inc.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.