| The S&P 500 energy sector is up over 60% this year while the overall market is down about 17% – that’s nearly 80% of outperformance! After such a strong year, one might assume that the run for energy stocks would be near its end. We’re not so sure. Here’s why: For perspective, over the past five years, the energy sector still trails the S&P 500 by 20%. Over the last ten years, that underperformance ballooned to nearly 150%. As a result, the energy sector still looks attractively valued from a price-to-earnings (P/E) perspective. In fact, the energy sector’s P/E ratio is lower today than it was at the beginning of the year – earnings expectations have increased faster than the price of the stocks. Finally, it appears as though the sensitivity of energy stocks to oil may have decreased. Lately, energy stocks have diverged from the price of oil. As oil has been pressured lower, the stocks have not followed. According to Strategas Research Partners: |
- Before the shale revolution, the correlation between the S&P 500 energy sector and the front-month WTI Crude Oil contract was .39 (low).
- Post-shale, this correlation ratcheted up to .68 as profitability took a back seat to production growth, therefore, making companies in the sector more sensitive to fluctuations in the underlying commodity.
- The correlation post-COVID has been .49. In our view, as energy companies have focused on capital discipline and profitability, they have become less sensitive to fluctuations in the underlying commodity and are therefore profitable at much lower oil prices.
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