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Schwab Sector Views

Schwab Sector Views: Drilling Down on Energy

Key Points
  • Crude oil and the energy sector have bounced back modestly from the sharp drop seen last year, but we don’t think it’s time to load up on energy stocks.

  • There are some bullish developments in the energy space that could help support the sector.

  • There are also some bearish undertones, in our view, that compel us to recommend that investors keep a neutral position in the energy sector.

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. 

Listen to the latest audio Schwab Sector Views.

Power being restored?

Oil, and the energy sector, have had a stomach-churning run over the past year, with WTI Crude moving from over $70/barrel early last year to below $50 near the end of the year, and then rebounding at the start of this year—so what’s an investor to do?

Wild ride for crude

WTI crude

Depending on whom you listen to, this may be the opportunity of a lifetime to get in the energy space at depressed prices—as declining oil reserves and OPEC discipline will mean steadily higher prices—or this recent rebound is a “dead cat bounce,” and abundant supplies and declining demand will result in disappointments for some time to come. 

Which view is true?

Both … and neither! These sorts of extreme opinions seem unique to the energy sector and contribute to sharp moves in either direction at times. We believe there is a bull and a bear case to be made for oil, and therefore the performance of the energy sector, with both having convincing elements. It is this tug of war, and our admitted inability to perfectly predict when sentiment is going to shift to one extreme or the other, that keeps us neutral on the energy sector. This means our view will likely underperform at times and outperform at times, but we believe it will average out to close to market performance. However, we’ll lay out some of the major bullish and bearish arguments—if one seems particularly convincing to you, may want to do some more investigating before jumping on one side or the other.

The bullish case

The longer-term bullish case for oil generally involves the idea that oil reserves are overstated and actually running out, and that ever-increasing demand will result in ever-higher prices. Long-time readers of this publication will know that I have been skeptical about the “running out of oil” story for some time—and continue to be so. But we’ll put that aside for a moment and focus on the nearer-term developments that have helped contribute to the recent rally. Late last year, The Wall Street Journal reported that OPEC and 10 other oil producers, including Russia, agreed to cut production by 1.2 million barrels per day (mbd) in the first half of 2019. Then, this week, The Wall Street Journal had another report that Saudi Arabia was planning to cut oil exports by 800,000 barrels per day from the November levels, which would appear to be more than the initial agreement. And for good reason they have reason to want higher oil prices. According to Ned Davis Research, Saudi Arabia’s 2019 budget, released in December, requires roughly $80/barrel oil prices in order to reach their revenue projections. And while Saudi Arabia’s Crown Prince Mohammed bin Salman has pushed to diversify the economy, the country’s own budget projects that 68% of total government revenues come from oil—a strong incentive to try to push prices higher. 

Additionally, we may be seeing some caution from U.S. producers, as Baker Hughes reported the oil rig count rose by only one rig in December, a potential flattening from the recent trend we’ve seen.

Rigs have been rising but may be flattening out

Rig count, oil

Finally, there have been reports on CNBC and other media outlets that the famous Permian Basin is facing supply constraints as the area doesn’t have the infrastructure needed to provide increasing amounts of oil. 

The bearish case

While OPEC can clearly still have an impact on the price of oil, we question how sustainable and large that impact is in this time period. The U.S. is importing less and less oil, with the Energy Information Administration reporting that in November, the U.S. was actually a net exporter of crude, while the Department of Energy reported that 2018 ended with the U.S. producing 11.6 mbd of crude, up from 9.7 mbd in 2017.

U.S. is importing less oil

crude oil imports - net

And there’s the political angle, which we won’t get into much as I don’t claim to be an expert in the political nuances that occur in the energy space. But I have noticed that Saudi Arabia has seemed to be at least somewhat sensitive to the pressure put on by the U.S. administration to keep prices lower. Whether that will continue, as the country needs higher prices to meet its obligations as described above, is impossible to know—at least by us!

And then there’s perhaps the biggest game-changer in the oil markets: the increase use of oil shale as a means of providing more domestic oil. The centerpiece of that effort is the Permian Basin, which isn’t the only area where shale oil is being extracted, but it is one of the more important and tends to get the most publicity. Indeed, there have been some problems with the size and number of pipes leaving the basin and them being at capacity—according to reports in The Wall Street Journal. But that situation seems to be short-lived, as the Journal is also reporting that new, wider pipes are being built and should be ready for action in early 2020. 

Also, while Saudi’s oil industry is a government monopoly that has an interest in keeping prices higher, the U.S. industry is privately run with lots of competition—and an incentive to drive down costs in order to maximize potential profitability. Evidence of that, if it was needed, was the presentation last month by Pioneer Resources, one of the biggest players in the Permian, which revealed that their breakeven price was less than $30 per barrel, while also noting that in seven other basins the company is operating in, the breakeven rate is roughly $30 per barrel. 

Finally, there is the demand side—which we won’t detail in this report, but with the global economy appearing to slow, demand could decrease. However, with China recently reducing its reserve requirements (Financial Times), a typical stimulative measure, and the U.S. Federal Reserve appearing to move to a more dovish stance (in our view), we believe demand will remain relative steady for the foreseeable future. 

It’s this mix of information that leads me to continue to suggest a market weighting to the energy sector. However, if you believe you have a better handle on the timing of sentiment changes, the ability to move quickly, and a high risk tolerance, there likely will be opportunities on both sides in the coming months. But as readers know, that kind of market timing is hard to accomplish and rarely successful, so we suggest sticking with a market weighting and riding the ups and downs.


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 1/15/19

Communications Underperform 09/28/2018 10% 8.03%

Consumer discretionary

Marketperform

07/17/2014

10%

7.64%

Consumer staples

Marketperform

05/07/2015

8%

2.53%

Energy

Marketperform

11/20/2014

5%

8.68%

Financials

Marketperform

08/16/2018

13%

5.46%

Health care

Outperform

01/26/2017

16%

3.69%

Industrials

Marketperform

01/29/2015

9%

6.09%

Information technology

Marketperform

08/16/2018

20%

4.11%

Materials

Marketperform

01/31/2013

3%

2.83%

Real estate

Marketperform

08/16/2018

3%

4.15%

Utilities

Marketperform

08/16/2018

3%

-0.20%

S&P 500®  Index (Large Cap)

 

 

 

5.10%

Source: Schwab Center for Financial Research and Standard and Poor’s as of 12/31/18.

 

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:

Schwab Market Perspective
Schwab Market Perspective: Rally Return or Continued Caution?
Real Estate Sector Rating: Marketperform
Real estate sector

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. . The above mentioned companies should not be construed as a recommendation or endorsement.

Diversification and rebalancing strategies do not ensure a profit and do not protect against losses in declining markets. Rebalancing may cause investors to incur transaction costs and, when rebalancing a non-retirement account, taxable events may be created that may affect your tax liability

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 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 information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market 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.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

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