Energy Sector Funds: High Gains Are Unlikely to Continue

June 25 2004 — Despite rises in oil prices, energy sector funds are unlikely to show growing returns in the near term. Though the energy sector has favorable prospects over the longer term, funds investing in stocks of energy companies can be very volatile.

“We expect year-over-year earnings gains for energy stocks to decelerate in the years ahead,” said Sam Stovall, chief investment strategist for Standard & Poor’s. “From a sector standpoint, Standard & Poor’s has a market weighting in energy, and in general, we feel energy stocks are fairly valued.”

Going forward, energy stock gains are likely to moderate because of the “definite possibility” that oil prices will decline, Stovall added. However, it is believed that the long-term prospects for the energy sector are favorable due to increased production in Saudi Arabia and Russia and heightened demand in China and the U.S.

“We believe as energy prices pull back, oil stocks have the potential to pull back or underperform,” said Fred Sturm, manager of Ivy Global Natural Resources/A (IGNAX). Though he says oil service stocks may trend higher as increased spending on oil exploration spurs revenue growth for oil service companies, he finds they “aren’t cheap at current levels.” Typically, half of the Ivy portfolio is invested in energy stocks, and half in basic materials stocks. For the one-year period through last month, Ivy Global Natural Resources rose 39.9%.

While oil prices have soared this year, energy sector funds have only moderately outpaced the broader market. For the one-year period through last month, energy sector funds rose 19.9%, versus a 18.23% gain for the S&P 500. But for longer periods, specifically past five years, energy sector funds have outperformed the S&P 500. On an annualized basis, they rose 7.64% for the five-year period through last month, versus a 1.52% loss for the S&P 500.