Oil stocks have been dead money for so long that not even Miracle Max from The Princess Bride would be able to restore them to life. But oil prices, which hit their highest level in 3½ years this past week, may have finally gotten high enough to make the stocks attractive to investors again.
Heading into last week, the energy sector was one of the market’s worst performers. It had dropped 6%, including reinvested dividends, through April 6, nearly three times the S&P 500’s 2.1% decline. But after surging nearly 6% last week, energy stocks have fallen just 1% in 2018, to the S&P 500’s 0.7% loss. Yes, you can call it a comeback.
And it’s one that may have staying power. While the energy sector’s rise came as oil prices spiked to their highest level since December 2014, oil stocks might not need further increases to fuel their rally.
The upshot: It might be time to buy energy stocks.
Thus far, 2018 has been a story of rising oil prices, but lagging energy stocks. West Texas Intermediate crude oil has risen 12% this year, and while it’s easy to credit the rise to tensions in the Middle East, turmoil in Venezuela, and other geopolitical events, it misses one obvious fact: Demand has been growing faster than production, according to data from a DWS Investments report, reversing the dynamics that led to oil’s tumble into its 2016 low.
But there are reasons to believe oil won’t head much higher. DWS says production has already started to increase again, and investors in the futures market are betting the price will rise—a sign much of the move might already be priced into the market. Still, “even in the absence of a further geopolitical escalation, the oil price seems to be well supported here,” the report concludes.
Stable—or even peaking—oil prices don’t mean the end of the energy-sector rally, however. U.S. oil producers have already started to lock in higher oil prices using futures contracts, explain Pavilion Global Markets strategists led by Alex Bellefleur. That means they’ll be less exposed if oil prices do fall, and should remain profitable either way. “If prices remain in the current range, U.S. production and pipeline companies will find themselves in a sweet spot, with improved earnings estimates,” Bellefleur writes.
The market might finally be coming around to that view. Last week, the Energy Select Sector SPDR exchange-traded fund (XLE) gained 6%, its biggest one-week gain since December 2016. That move has started to get the sector noticed by technical analysts like Vermilion Research’s David Nicoski, who upgraded the energy sector to Market Weight last week. “Supported by rising oil prices, shares of U.S. energy companies are bullishly inflecting,” Nicoski writes.
Analysts have already started touting their favorite stocks. Last week, for instance, Goldman Sachs analyst Brian Singer placed Pioneer Natural Resources (PXD) on the firm’s Conviction List, citing its ability to return cash to investors through dividends and share repurchases. Pioneer has gained 9% in 2018, making it the 10th-best-performing energy stock in the S&P 500.
But if this really is the turn for energy, aiming lower—a lot lower—could make sense. Cimarex Energy (XEC) has been the worst-performing energy stock in the S&P 500 so far this year after dropping 23%, as concerns about the amount of oil it produces relative to natural gas weigh on its shares. But Nicholas Colas, co-founder of DataTrek Research, points out that when a sector turns, it lifts all boats. “Sometimes when investor sentiment turns positive on a sector, the laggards can move the most,” he explains.
And it might not even take a miracle.
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