5 Reasons Energy Stocks Could Surge

Energy stocks, largely abandoned by investors this year even as oil prices have bounced back from their lows, finally could be set for a rebound. While the SPDR Energy Select Sector Fund (XLE) is down more than 1% on the year compared to the more than 16% gain of the S&P 500, Dubravko Lakos-Bujas, JPMorgan Chase & Co.’s (JPM) chief U.S. equity strategist, recently laid out five major reasons why oil and gas stocks were ready to surge, according to Business Insider.

“We believe favorable technicals, improving fundamentals with stabilizing business cycle, and ongoing geopolitical tensions in the Middle East could help redirect flows into this universally hated and cheap sector,” he wrote in a note to clients. Three energy exchange-traded funds (ETFs) that may benefit include the SPDR S&P Oil & Gas Exploration Production ETF (XOP), the VanEck Vectors Oil Refiners ETF (CRAK), and the VanEck Vectors Oil Services ETF (OIH).

Key Takeaways

  • Energy stocks at ultra-low valuations.
  • Energy companies are increasing dividends and buybacks.
  • Tensions in Middle East could restrict oil supply.
  • Expectations of pick up in U.S. economy.
  • Highly leveraged energy companies to benefit from higher oil prices.

What it Means for Investors

One of the surprising things this year has been the failure of energy stocks to rally along with the price of oil. The price of West Texas Intermediate (WTI) fell below $43 a barrel in late December of last year before bouncing back in the first half of 2019. The price now sits about 26% higher than those late-December lows. Meanwhile, energy stocks have basically lost all of the gains they made in the first four months of the year.

Tobias Levkovich, a U.S. equity strategist at Citigroup Inc., wrote in a research report in early August, “The energy sector has been a disappointment for investors in 2019, generating the worst return of all sectors.” His sentiments were echoed by Eric Nuttall, senior portfolio manager of Ninepoint Partners, who wrote, “The energy sector is suffering from one very clear problem: there are NO buyers of energy stocks,” according to Bloomberg.

But Lakos-Bujas thinks that’s about to change, and here are his five reasons why.

Five Reasons Energy Stocks have Upside

Reason number one to be bullish on energy stocks is their relative cheapness. The sector looks extremely undervalued as institutional investors have abandoned their positions in energy stocks and systematic funds are shorting oil. “Absolute and relative valuations are at lows with small-cap E&Ps trading below book value and at price levels seen almost 25 years ago,” Lakos-Bujas said.

The second major reason is that energy-sector returns are improving. Energy companies are increasing dividends and, with their stock prices as low as they are, are buying them back. Insider buying activity is now at an all-time high and yields on energy companies have jumped to 3.9%, he said. 

Thirdly, tensions in the Middle East have risen, most notably after the drone attack on Saudi Arabia’s state oil facilities. While oil prices originally spiked, they have since come down again, and energy stocks barely budged with two-thirds of them trading below their pre-attack levels. That just doesn’t make any sense according to Lakos-Bujas, who expects to see U.S. oil stocks rise as Middle East oil supply uncertainty continues. 

His fourth reason concerns the broader outlook for U.S. economic growth, which he sees picking up in the next several months. The ongoing U.S.–China trade war and a slower growing global economy have posed major headwinds for the energy sector, but recent monetary easing from global central banks will help to reverse the slowdown and increased stimulus will help to boost growth in the not-too-distant future.

Lastly, Lakos-Bujas believes there is a lot of unappreciated upside in the energy sector, which he notes is highly leveraged. With oil prices expected to rise by roughly $5 a barrel next year, that high leverage will help generate enormous gains for energy companies. Increasing gains should encourage even bigger dividends and more buybacks, which should in turn help to push the multiples of energy stocks higher.

Looking Ahead

Lakos-Bujas’ thesis is dependent on the U.S. economy recovering over the next few months, but there is still a lot of mixed sentiment on that front. Recent weakness in U.S. manufacturing data and signs that the global economy continues to slow put that thesis in question. One bright spot, however, was Friday’s jobs report, which showed U.S. unemployment falling to its lowest since 1969 as employers added 136,000 jobs. 

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