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Schwab Sector Views

Schwab Sector Views: Sustainable Energy?

Key Points
  • The energy sector has rallied over the past couple of months, fueled by the perception that oil producers are showing greater discipline in restricting output.

  • The energy sector can be volatile and speculative and we see some signs that the current rally may not be sustainable.

  • We believe investors should keep a market weighting position in the group.

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 staged an impressive comeback over the past couple of months after a difficult first half of the year, though the sector is still among the worst performing groups of 2017.  As often seen, the energy sector has largely followed the price of oil higher, with WTI Crude moving from the low $40 per barrel range in June to the low $50 per barrel range recently.  As oil has moved higher, the number of short sellers in the energy space (investors side against the group) has declined substantially, according to Evercore ISI Research, indicating improved sentiment toward a group that had been beaten up through the middle of August.

This recent rally appears to have been fueled by a variety of factors. Hurricanes hit oil producing areas, and the dented production likely played a part by temporarily restricting supply. In our view, a bigger factor may be the perception that oil producers are becoming more disciplined in restricting the amount of crude they put out on the market.  For example, the rig count in the U.S. has recently flattened out, and even turned slightly lower.

Are oil producers exercising more discipline?

Baker-Hughes Rotary Rig Count, Oil

Source: FactSet, Baker Hughes, Inc. As of Oct. 9, 2017.

And the September 22nd OPEC meeting also appeared to feed that sentiment. Although they didn’t extend their agreement to cut oil production past the current March 2018 ending date, according to UPI, they noted they would likely look to extend it through the end of 2018 at a future meeting, while also reporting that they had compliance with the cuts at 116% at the end of August—one of the highest levels ever. However, we also must note that Reuters reported that at the end of September the compliance rate of OPEC and the non-OPEC members in the agreement was 86%, still decent, but not quite as optimistic as the rate reported by OPEC.  Also according to Reuters, there are elevated concerns that Turkey could shut down the production of roughly 500,000 barrels per day (bpd) from the Kurdistan region of Iraq following their vote for independence. 

Finally, a level of “oversold” sentiment appeared to develop among some investors. We saw a rotation in the sector world as some money came out of the best performing sector for the year—technology—and went into the worst performing sector of the year—energy—based on the performance of both sectors through August and part of September. 

Of course, the questions now are: Can this rally continue and should investors jump on?

Part of the reason that we have held a market weighting on the energy sector for this year despite the underperformance is because we knew that energy can be volatile and can reverse direction quite quickly for relatively little fundamental reasons.  We can see the volatility by the beta reported by Cornerstone Macro Research of 1.22, (which basically means the energy sector has moved in the same direction as the overall market but to a 22% greater degree) which is the second highest among sectors. Trying to time these moves for the average investor is incredibly difficult and we believed over time the sector would perform roughly in line with the overall market—although not in a straight line.

And while we are sticking with our market weighting, we aren’t upgrading the sector at this point and would urge investors not to load up and overweight the energy sector despite the recent rally.  We remain skeptical that oil producers can maintain long-term discipline.  For example, there already is grumbling among OPEC members. The Iranian oil minister has complained that Libya and Nigeria aren’t part of the agreement and are increasing production, according to Bloomberg.  In fact, a pipeline that was closed for repair in Libya that took over 1 mbd offline has been repaired and, again according to Bloomberg, will be producing just less than 1mbd in the near future, with the country not even considering limiting production until they get to at least 1.25 mbd. Additionally, we are skeptical that the rig count in the U.S. will continue to trend lower.  These companies are in the business of making money and we have reported previously in this space that the costs of drilling wells and getting rigs up and running again continues to drop as technology and techniques improve, meaning they can make money at lower prices.  In fact, we’ve seen production in the U.S. continue to increase, while the Energy Information Agency (EIA) projects that U.S. production will rise from an average of about 9.3 mbd in 2017 to a record 9.8 mbd in 2018.

After hurricane disruption, U.S. oil production continues to rise

U.S. Crude Oil Field Production (thousands of barrels per day)

Source: FactSet, U.S. Dept. of Energy. As of Oct. 9, 2017.

And there appeared to be some concerns that the Permian Basin, where much of the improved production due to shale oil is coming from, may not be as productive as initially hoped. Although it is typical to see some overly optimistic projections, research firm IHS Markit recently estimated that there is at least 60-70 billion barrels of recoverable crude in the basin, which still seems fairly positive to us. And while demand for crude has increased —and should continue to do so in the near term amid a growing global economy —it is our belief that U.S. production can easily cover that rise in demand.  Additionally, there are more stories of major oil users trying to move away from that energy source.  The New York Times reported last month that both France and Britain have announced plans to ban new gas and diesel cars by 2040.  Additionally, major car makers are increasingly moving toward electric cars. GM executives have stated they believe in “an all-electric future”, according to Business Insider, while Volvo announced that, starting in 2019, all new cars will be either fully electric or hybrid. 

We are admittedly skeptical that these pronouncements will come to pass as stated, but there is momentum around the world to move energy production away from oil. Ultimately, we believe energy companies will adapt and be leaders in non-oil energy sources, while the death knell of oil is still a long ways off, the prevailing sentiment could weigh on any sustainable energy rally.  As a result of this bifurcated picture, we suggest investors keep a market weighting toward the sector, and enjoy the recent rally that has pulled the group back from the depths.

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 10/10/2017

Consumer discretionary

Marketperform

07/17/2014

12%

13.48%

Consumer staples

Marketperform

05/07/2015

9%

7.06%

Energy

Marketperform

11/20/2014

6%

-6.85%

Financials

Outperform

05/07/2015

15%

14.76%

Health care

Outperform

01/26/2017

14%

21.48%

Industrials

Marketperform

01/29/2015

10%

15.33%

Information technology

Outperform

04/29/2010

23%

29.70%

Materials

Marketperform

01/31/2013

3%

18.12%

Real estate

Underperform

01/26/2017-

3%

8.31%

Telecom

Underperform

09/12/2013

2%

-4.42%

Utilities

Underperform

05/23/2013

3%

13.93%

S&P 500®  Index (Large Cap)

 

 

 

15.73%

Source: Schwab Center for Financial Research and Standard and Poor’s as of 09/29/17.

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.

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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Important Disclosures

Schwab Sector Views do not represent a personalized recommendation of a particular investment strategy to you. You should not buy or sell an investment without first considering whether it is appropriate for you and your portfolio. Additionally, you should review and consider any recent market news.

Performance may be affected by risks associated with non-diversification, including investments in specific sectors. Each individual investor should consider these risks carefully before investing in a particular security or strategy.

All expressions of opinion are subject to change without notice in reaction to shifting market and other conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly. Past performance is no guarantee of future results.

The S&P 500 Index is a market-capitalization-weighted index comprising 500 widely traded stocks chosen for market size, liquidity and industry group representation.

The S&P 500® Food Retail Sub Index comprises those companies included in the S&P 500 that are classified as members of the GICS® Consumer Staples sector.

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.

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