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Schwab Sector Views

Schwab Sector Views: Drilling Down on Energy

Key Points
  • The energy sector has started to catch up to the gain in oil prices, but the sector can be volatile and we remain more cautious than the consensus.

  • Sentiment toward oil prices appears to be extended, which could portend a pullback in both the commodity and the sector.

  • There is a bullish case to be made for energy. For those willing to take higher risks, adding to positions may be appropriate, but be wary of the potential risks involved.

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 more things change …

Oil prices have staged a solid rally over the past year, with WTI crude moving from around $50/barrel a year ago to close to $70/barrel currently—a roughly 40% gain. However, as you can see below, the energy sector hadn’t kept up with the commodity gains until a very recent move higher.

The energy sector hasn’t kept up with crude prices.

Past performance is no guarantee of future results

Now that the sector has started to move higher, the potential for the gap to close has excited much of Wall Street, with more bullish calls coming out for both the sector and for oil. The gap, however, could be closed by oil coming down to meet the energy sector line, a possibility that seems to be ignored by much of the current analysis, likely largely due to the bullish view on the future of oil prices. Two other charts appear to indicate that in the past, gaps in traditional relationships have been closed more by the commodity price moving to the stock-related price than the other way around. History is no guarantee of future performance, but it does leave open the possibility of a different outcome.

Oil can experience sharp moves to catch up to the sector …

… likewise to catch the energy/transportation ratio.

 

But if the price of oil continues to rise, which is the consensus forecast, it seems likely to us that the energy sector will continue to outperform. And there is a solid bull case to be made for oil. OPEC and Russian cuts to production of roughly 1.8 million barrels per day (bpd) have held for the past year and a half, and statements coming out of Saudi Arabia, which has accounted for roughly 700,000 of those barrels cut (Cornerstone Analytics) indicate to us that they intend to at least hold those cuts for the foreseeable future. This despite the International Energy Agency saying recently that OPEC should declare “mission accomplished” if it were targeting reducing global oil inventories back in line with the five-year average. And the U.S. Energy Information Administration (EIA) reported that inventories are now in the bottom half of the average range for this time of the year.

Geopolitical issues also are affecting the bullish outlook for oil. Venezuelan production has fallen by 27.7% since December 2016 (Financial Times) and with the recent evacuation of Chevron personnel from the country due to the growing perceived chaos, it seems likely that more Venezuelan barrels will be taken off the market in the coming months. Additionally, Iranian production, which has risen since December 2016, could be threatened on the global market following the Trump administration decision to exit the nuclear treaty, should sanctions on oil exports follow.

The demand side also can’t be ignored. The Financial Times reports that global demand has increased by more than five million bpd over the past three years, while you can see from the chart below that the U.S. demand for both crude oil and gasoline has moved higher recently. And with the International Monetary Fund projecting global economic growth to be 3.9% in both 2018 and 2019, that would seem to be supportive of the continued increase in demand for energy.

Energy demand is rising.

So what’s the problem?

Given the bullish story, why do we remain reluctant to raise the rating and urge clients to jump in with both feet? One word: risk. We believe that for many of our investors, the risks involved with having an outsized position in energy at this time are elevated. As you can see from the long-term oil chart below, the price can move lower in a rapid fashion. In fact, going all the way back to the 1980 time period, the peak in prices occurred close to the time various experts were expecting ever higher prices, such as the IEA (International Energy Agency) noting in 1981 that “In moving toward 1990, the industrialized countries will be walking an oil tightrope (Wall Street Journal). And some of the “irrational exuberance” appears to be in place now, with Ned Davis Research showing that there is currently a multi-year low in short energy positions (meaning bets against energy) established by hedge funds, while Oil.com is reporting that the hedge fund ratio of long positions to short is 15-1—the most lopsided in their history.

We also look to the ability of the U.S. to increase production relatively rapidly by putting oil rigs back into production that had been taken off following the crash in oil prices. In fact, you can see below that rigs are being put back to work, while the EIA’s most recent report notes that rigs are becoming more productive and companies are employing more effective drilling techniques.

U.S. rigs are rising …

… helping to push U.S. production higher.

On the demand side, U.S. driving miles have bounced off their recession dip, but the upward trend appears to be flatter than during the pre-recession era, while European economies may be slowing somewhat, with Markit reporting manufacturing PMIs declining, although remaining in expansion territory, for the fourth-straight month to start the year.

Miles driven may be flattening out.

So what to do?

We believe the potential is there for oil and the energy sector to move higher over the several months, but also that the risks of a sharp reversal are substantial enough that most investors would be better served to keep a market weight toward the group. For those investors willing to stomach some potentially higher risk, a modest overweight toward the sector may be appropriate, but be prepared for some potentially stomach-churning moves. Should sentiment correct and U.S. rigs being put back into production slow, we would likely look to raise our rating for the group, but for now we remain neutral.

 

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 05/08/18

Consumer discretionary

Marketperform

07/17/2014

13%

5.76%

Consumer staples

Marketperform

05/07/2015

7%

-13.39%

Energy

Marketperform

11/20/2014

5%

3.98%

Financials

Outperform

05/07/2015

15%

-0.61%

Health care

Outperform

01/26/2017

14%

-2.40%

Industrials

Marketperform

01/29/2015

10%

-2.93%

Information technology

Outperform

04/29/2010

25%

8.69%

Materials

Marketperform

01/31/2013

3%

-4.27%

Real estate

Underperform

01/26/2017-

3%

-4.77%

Telecom

Underperform

09/12/2013

2%

-11.90%

Utilities

Underperform

05/23/2013

3%

-4.35%

S&P 500®  Index (Large Cap)

 

 

 

0.55%

Source: Schwab Center for Financial Research and Standard and Poor’s as of 04/30/18.

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.

What You Can Do Next

To discuss how this article might affect your investment decisions:

Affective Forecasting: Can You Really Know Your Future Self?
Materials Sector Rating: Marketperform

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.

All expressions of opinion are subject to change without notice in reaction to shifting market or 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 and rebalancing strategies do not ensure a profit and do not protect against losses in declining markets.

The policy analysis provided by the Charles Schwab & Co., Inc., does not constitute and should not be interpreted as an endorsement of any political party.

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® Energy Index comprises those companies included in the S&P 500 that are classified as members of the GICS® energy sector.

S&P 500 Transporation Index is designed to measure the performance of narrow GICS® sub-industries. The Index comprises stocks in the S&P Total Market Index that are classified in the GICS transportation sub-industry.

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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