Schwab Sector Views: Is Energy an Opportunity or a Trap?

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.

The energy sector has had a rough start to the year—it’s actually competing with the telecom sector for last place in terms of sector performance. For investors who like to look for potential opportunities in beaten down parts of the market, the energy sector’s rough run could be a source of temptation, especially at a time when some other parts of the market seem to have elevated valuations. But just because something has been down doesn’t mean it can’t go lower. So what is the current outlook for the energy sector…potential opportunity or black hole?

The first thing to note is that despite all the talk about different sources of energy—from wind and solar to lithium batteries and other potential sources—the energy sector still continues to track oil prices pretty closely, so that’s where we’ll generally focus. When the energy sector starts to decouple from the price of oil on a consistent basis, then it’ll be time to consider giving more weight to some of these other sources.

The energy sector tracks the price of oil pretty closely

Source: FactSet, Standard & Poor’s, Nymex. As of 5/8/2017.

Oil prices have stayed in the $45–$55 range so far this year, around where we feel supply and demand come into a rough balance, at least for the time being. Many different factors have a role in driving the price moves we’ve seen. A Dallas Fed survey of energy executives quoted one respondent as saying “I can’t recall a time when the energy business indicators seemed so mixed and uncertain.”

A lot of that uncertainty comes from the opposed forces at play in the oil market. First, the Organization of Petroleum Exporting Countries (OPEC) agreed to cut production in December in a bid to boost prices. Those cuts, which included 11 other non-OPEC countries, including Russia, amounted to 1.8 million barrels per day (MBD). History is full of cases of cheating on production cuts, but this time seems a little different. Reuters reported compliance was about 90% in April, down from 92% in March, but still good. Further, Bloomberg recently quoted the Saudi Arabian Energy Minister as saying the consensus among OPEC members is that the production restraints will likely remain in place for the rest of this year. However, according to Morningstar, OPEC members are pessimistic about the agreement holding beyond that.

Why? Prices did rise modestly after the agreement was struck—but they have since settled.

That brings us to another important force at work in oil markets—the U.S. response to price changes. We’ve seen rig counts rebound along with U.S. production, which has helped to offset the OPEC cuts.

Rigs and production have risen in the U.S.

Source: FactSet, U.S. Dept. of Energy, Baker-Hughes, Inc. As of May 8, 2017.

These rigs have been put back into use even as the price of oil is still down more than 50% from its all-time high as energy companies have driven down the costs involved in pumping. The Dallas Federal Reserve Survey of energy executives showed that the breakeven point for the various drilling areas in Texas and Oklahoma has dropped to $24–$38. Bloomberg quoted the head of U.S. oil and gas at consultants Ernst & Young in Houston as saying “Everyone is driving breakeven prices down. It isn’t just shale companies, it’s everyone, from deep-water to commercial.” Bloomberg also quoted an executive of a major oil company as saying the company had been able to reduce the cost of drilling deep water wells by 50% over the past two years, and that “We are going to see more material cost saving in the next couple of years.”

And the Trump administration seems to favor opening more areas to drilling, which could further pressure prices as supply rises. The new Secretary of the Interior recently signed an order directing immediate development of the outer-continental shelf leasing program, according to Bloomberg, which includes offshore drilling in Alaska, the east coast and the Gulf of Mexico. When doing so he also said, “The U.S. is in position to be energy dominant, not just energy independent, thanks to fracking and looser drilling regulations.”

And then there’s the demand side, often overlooked but an important part of the price equation. World economic growth has improved, according to Markit’s PMI surveys, which have largely moved into positive territory around the world. That should help to bolster demand. But the correlation between economic growth and growth in oil demand may be changing, as other sources of energy are becoming more viable. In fact, we’ve seen demand in the U.S. rebound since the recession, but it has been slow to recover and still remains well below the level seen prior to the recession, indicating changing behavior among U.S. consumers and businesses.

U.S. demand has been slow to improve

Source: FactSet, Oxford Economics. As of May 8, 2017.

The recent earnings season showed that major energy companies are driving down costs and had profit reports that bested estimates, for the most part. To us, that means we could start to see some buying in the energy sector and some mean reversion after the sharp downturn. Additionally, there is always the threat of geopolitical conflict, which could increase the price of oil in a relatively quick manner.

So, while we don’t think this is the time to load up on energy companies—due to both supply and demand issues—we do think a neutral allocation is appropriate. The recent downturn provides an opportunity to add to positions as needed. The energy sector is in a complex situation, and we will continue to monitor developments and update our recommendations as needed.

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 05/09/2017

Consumer discretionary

Marketperform

07/17/2014

12%

12.06%

Consumer staples

Marketperform

05/07/2015

9%

7.09%

Energy

Marketperform

11/20/2014

7%

-10.15%

Financials

Outperform

05/07/2015

14%

2.40%

Health care

Outperform

01/26/2017

14%

10.17%

Industrials

Marketperform

01/29/2015

10%

7.28%

Information technology

Outperform

04/29/2010

23%

17.72%

Materials

Marketperform

01/31/2013

3%

6.38%

Real estate

Underperform

01/26/2017-

3%

3.05%

Telecom

Underperform

09/12/2013

2%

-8.59%

Utilities

Underperform

05/23/2013

3%

6.43%

S&P 500®  Index (Large Cap)

 

 

 

7.77%

Source: Schwab Center for Financial Research and Standard and Poor’s as of 4/28/17.

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.

   Was this helpful?  

Subscribe:

Subscribe to Emails Subscribe via RSS

Important Disclosures