Although the outlook on oil prices and demand has become increasingly uncertain in recent months, analysts continue to recommend the underperforming energy stocks as a good bet for investors.
Energy has the highest share of the stocks with “buy” recommendations of all 11 sectors of the S&P 500, according to ratings from Wall Street analysts compiled by Bloomberg.
Many experts cite the cheap valuations of the energy sector and the pro-oil and gas policies of the Trump Administration as key drivers of future stock growth. Moreover, energy commodities could offer protection against inflation, which could accelerate due to President Trump’s chaotic on-and-off trade and tariff policies.
“Historically, energy generated the strongest real returns across assets when inflation surprised to the upside,” Goldman Sachs said last year.
The investment bank’s analysis found that inflation surprises to the upside usually boost real returns for commodities, and lower returns for equities and bonds.
This summer, Wall Street analysts believe that energy stocks can stage a rebound in the coming year.
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The energy sector in the S&P 500 index boasts the highest proportion of stocks rated ‘buy’ by analysts—74%, per the data compiled by Bloomberg. Information technology is the second most recommended sector, with 65% of stocks rated ‘buy’ by analysts.
The average for all S&P sectors is about 50% buy-rated stocks.
This suggests that the Street is more bullish on energy overall than on Big Tech as a whole.
A key reason for this is that the energy sector looks very cheap in terms of stock price to earnings ratio.
It’s actually the cheapest of all 11 sectors.
“The thesis that some people have is that multiples and valuations are very, very low right now,” Leo Mariani, analyst at Roth Capital Partners, told Bloomberg in an interview.
Low valuations and the past underperformance are setting the stage for a comeback of the oil and gas stocks, according to analysts.
For example, sell-side analysts forecast energy stocks will grow by about 16% over the next 12 months, double the expected rise of the S&P 500 index, and the second-highest growth rate among the 11 sectors, trailing only behind health care, Bloomberg’s data show.
So far this year, the energy sector has underperformed the S&P 500, with a gain of 3.16% year to date, compared to a 7.3% rise for the broader index as of July 22.
The Oil & Gas E&P subsector has underperformed even more, losing 6.52% year to date. The 1-year return for the subsector is a negative 16.95%, compared to a 14.62% return of the S&P 500.
Despite the Street’s bullish view on the energy sector, investors seem unconvinced.
Uncertainty about oil demand and prices is trumping the power of the inflation hedge attributed to commodities.
Moreover, fluctuating and lower oil prices would stifle earnings at oil and gas companies.
“Earnings growth might struggle if oil prices continue to fall on the heels of both relatively weak demand and a continued recovery in supply,” analysts at the Schwab Center for Financial Research (SCFR) wrote last week in a monthly outlook on the 11 S&P 500 sectors.
“While Energy tends to be cyclical and to do well when the Federal Reserve is cutting rates slowly, global commodity prices (particularly oil) fall under pressure if growth continues to slow.”
SCFR has had a Marketperform rating on all sectors since the first major tariff blitz in early April.
“Until we have more clarity on trade policy we are cautious about asserting an Outperform or Underperform view on any sector,” the analysts wrote.
Major oil companies themselves have warned of lower earnings for the second quarter on the back of the decline in oil and gas prices compared to early this year and this time last year.
By Tsvetana Paraskova for Oilprice.com
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