Schwab Sector Views: Time to “Energize” Your Portfolio?

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.

By many measures, including price-to-earnings ratios, stocks appear to be fully valued. As such, investors may be looking for areas of the market where they may find some value. And given the poor performance of the energy sector to this point in the year—down over 11% and the worst performing sector in 2017—is this the place where some “bargains” can be picked up?

The energy sector’s performance has shown some signs of improvement. Over the past month, it has roughly kept up with the overall market. However, despite the underperformance over the past 12 months, the sector isn’t at what we consider to be undervalued levels. According to the BCA Research valuation indicator, which takes multiple metrics into account, the energy sector is roughly at fair value. That makes sense since the major revenue producer for much of the energy sector—oil—has also fallen over the past few years and it has taken a bit of time for these energy companies to get their costs back in line with revenues that can be more reasonably expected over the coming quarters.

Crude’s fall hurt energy shares, but may be stabilizing

Source: FactSet, Dow Jones & Co. As of July 31, 2017.

Even though valuations aren’t a screaming buy, it doesn’t mean that the outlook for the sector isn’t brightening because, in our view, it is. As shown in the above chart, crude appears to have stabilized in the roughly $45-$55 dollar range, which should allow energy companies to better plan. BCA Research also notes that both profit margin and earnings growth in the energy sector is expanding. Additionally, Strategas Research Partners expects energy to be the top earnings growing sector in both 2017 and 2018—of course that is partially due to a low starting point, but it could bode well for stock prices in the coming months. Further, the dollar has weakened through the first part of 2017, which should help to bolster energy companies’ earnings. The energy sector is the top sector for foreign sales, with almost 59% of its revenue coming from overseas, according to Strategas. 

Weaker dollar could help energy companies

Source: FactSet, Intercontinental Exchange. As of July 31, 2017.

One of the problems with the energy sector has been that the abundant supply of oil. OPEC has tried to limit supplies in an effort to bolster prices, with a December agreement between 14 OPEC and 10 non-OPEC oil producing countries to reduce global oil supply by 2% being the largest occurrence thus far, according to the Wall Street Journal. However, getting countries to stick to that agreement has appeared to be somewhat difficult as Petro Logistics reported that OPEC production reached a new record last month. Part of the problem is that Nigeria and Libya were excluded from the agreement, but the Wall Street Journal is reporting the OPEC is now attempting to get those countries on board as well. But with much of these countries’ budgets dependent on revenue from oil sales, it seems to us that long-term adherence to these agreements may prove difficult.

And it may not matter all that much anyway. The impact of OPEC appears to have diminished as there was limited reaction to their December announcement. U.S. production now appears to be a driver of price, as rigs were put back into action as oil prices stabilized, offsetting at least some of the cuts from OPEC. But the good news for energy companies is that rig additions appears to be slowing, which could signal some discipline among energy executives and bode slightly better for the price of oil in the near future.

Rig additions may be slowing

Source: FactSet, Baker Hughes, Inc. As of July 31, 2017.

Additionally, we’ve seen energy companies reduce the costs of drilling in many areas. For example, Pioneer Energy noted that the breakeven price of oil in the famous Permian Basin for the company was down to about $22-$28 per barrel.

We’ve also seen some regulatory burden reduced. One of the biggest changes is the allowance of crude oil to be exported, making the oil market more of a global one and benefitting domestic energy companies, in our view.

Oil exports have spiked

Source: FactSet, U.S. Dept. of Energy. As of July 31, 2017.

And the demand side appears to us to be brightening as well. Some indicators we watch for economic activity have picked up as the Institute for Supply Management’s Manufacturing Index indicates strength in US manufacturing, while Markit reports the European PMIs remain elevated—both potential positive for oil demand. Copper has historically been viewed as an indicator of global economic activity and while that indicator may be less useful today, the recent rebound still bodes well for economic growth in our view. 

Copper rebound is encouraging

FactSet, U.S. Dept. of Agriculture, NYMEX. As of July 31, 2017.

Finally, a more granular look at oil demand paints a positive picture with the International Energy Agency noting the global oil demand growth rose from 1.0 million barrels per day (mbd) in the first quarter to 1.5 mbd in the second quarter.

So where does that leave us? We’re not quite ready to boost the rating of the energy sector to outperform. We want to see if the seemingly newly increased discipline on the supply side holds and whether demand continues to improve in light of the push for more electric cars and other alternative forms of energy. But we do think that the situation has improved enough for us to keep our market perform rating, which admittedly was overly optimistic through the first part of the year. For those investors who have shunned investments in the energy sector as of late, we suggest bringing allocations up to a market weighting, while keeping an eye on our recommendations to see if there is an opportunity to go even further.                                                                                                   

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 08/01/2017

Consumer discretionary

Marketperform

07/17/2014

12%

13.32%

Consumer staples

Marketperform

05/07/2015

9%

8.54%

Energy

Marketperform

11/20/2014

6%

-10.37%

Financials

Outperform

05/07/2015

15%

9.61%

Health care

Outperform

01/26/2017

14%

16.71%

Industrials

Marketperform

01/29/2015

10%

9.33%

Information technology

Outperform

04/29/2010

23%

22.95%

Materials

Marketperform

01/31/2013

3%

11.08%

Real estate

Underperform

01/26/2017-

3%

8.10%

Telecom

Underperform

09/12/2013

2%

-4.78%

Utilities

Underperform

05/23/2013

3%

11.98%

S&P 500®  Index (Large Cap)

 

 

 

11.86%

Source: Schwab Center for Financial Research and Standard and Poor’s as of 07/31/17.

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
To discuss how this article might affect your investment decisions:
-          Call Schwab anytime at 877-338-0192.
-          Talk to a Schwab Financial Consultant at your local branch.

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