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Energy Sector

Energy Sector Rating: Marketperform

Energy sector overview

Global growth worries, combined with oversupply concerns in the oil arena, have appeared to weigh on the energy sector. Geopolitical events are unpredictable and often impact the energy sector, which should be taken into account along with the fundamentals of the group.

Market outlook for the energy sector

The energy sector has had rough few months, being the worst performing sector in the S&P 500 over that period. Oversupply concerns appear to be the major reasons behind the recent selling as U.S. production has ramped up, Saudi Arabia continues to pump at record levels (Reuters), while the sanctions on Iran were accompanied by waivers that appeared to be bigger than expected. Global growth concerns also likely played at least a minor part in the recent pullback. . But with sanctions officially reimposed on Iran and the waivers scheduled to expire, OPEC members making noise about cutting production (Wall Street Journal), and geopolitical risk existing, we are hesitant to go underweight at this point as we’ve seen sharp rebounds over the past year that we believe could happen again. Additionally, the energy sector tends to be a better performer later in the business cycle, which is where we believe we are—so we are keeping our marketperform rating on the group…for now.

Taking a little larger view, the energy sector’s performance has been volatile this year, with investors attempting to balance a U.S. demand that allies stop using Iranian oil, trade friction, and both inventory and supply concerns. These crosscurrents keep us at marketperform for the group as mentioned as we don’t know where the balancing point is for the price of oil, but believe we may be close to it. Additionally, American oil production continues to move higher, according to the Energy Information Agency, causing a bit more concern among investors. This illustrates why we’re still concerned that the discipline shown on the supply side both with OPEC and here in the U.S. won’t last as companies and countries chase profits. Additionally, according to Baker Hughes, the rig count in the U.S. has started to move higher again after a brief dip.

We admit to being more cautious than others recently with regard to the energy sector, due largely to the potential risks of a sharp turnaround—much as we’ve seen in the past—but we aren’t opposed to those with higher risk tolerances looking at some of the higher-quality companies in energy after the recent rout the sector has undergone, understanding that reversals are quite possible, such as we’ve seen over the past few months. Despite our caution, there remain bullish developments and should discipline among producers continue to hold—both domestically and globally, we would consider upgrading the group. Additionally, global growth concerns could dampen the price as trade concerns rise, and could affect global activity. But at this point we don’t think growth will deteriorate to the point of producing a reduction in the need for oil, keeping us in the marketperform camp—for now.

It is often said that the cure for high energy prices is high energy prices and we could have gotten close to that point, leading to our continued hesitation to raise the overall weighting on the group. So, for now, we believe the factors outlined above support a rating of marketperform.

Factors that may affect the energy sector

Positive factors for the energy sector include:

  • Potential increase in energy demand: The U.S. economy is growing, and developing nations will likely need more energy as they improve their infrastructure and modernize their economies.
  • Rising geopolitical tensions: These tensions, if raised, could result in higher oil prices.

Negative factors for the energy sector include:

  • New supply: Energy supply has increased dramatically with a renewed commitment to exploration and technological improvements.
  • Increased conservation: Conservation efforts and new technology could affect the growth in demand for energy products.
  • Energy use restrictions: Severe pollution problems in China could result in mandates to cut energy use

 

Clients can see our top-rated stocks in the energy sector.

Want to learn more about a specific sector?  Click on a link below for more information or visit Schwab Sector Views to see how they compare.

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