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Portfolio > Economy & Markets > Stocks

Time to Buy Oil Stocks?

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To all those investors and advisors shying away from energy stocks because of their underperformance this year and last, Sam Stovall, U.S. equity strategist at S&P Capital IQ, has a message for you: Don’t.       

“There comes a point in which a group becomes so unloved that it begs to be bought and put away for an eventual recovery,” Stovall writes in his latest U.S. Equity Research Sector Watch note. “Today, global energy stocks could be making that same plea.”

Over the past year the S&P Global 1200 Energy Sector Index has fallen 22.4% while the broader S&P Global 1200 index has gained 1.87%. The energy sector, which peaked in 2008, is trading well below its average — more than two standard deviations below — which may represent a long-term buying opportunity, writes Stovall.

He recommends that investors combine purchases of energy stocks with purchases of consumer staples and technology, in equal parts. “In the past 10 years, a portfolio consisting of an equal exposure to the S&P Global 1200 consumer staples, energy and tech sectors produced a higher compound annual growth rate than the S&P Global 1200 with lower volatility,” writes Stovall.  He calls the portfolio a “free lunch,” getting “something for nothing — higher return with lower volatility.”

Over the past 20 years a hypothetical portfolio evenly divided among these three sectors, rebalanced annually, returned a compound annual growth rate (CAGR) of 8.7%, compared with just 6% for the S&P Global 1200 index, according to Stovall. The sectors are not well correlated and tend to outperform during different phases of the economic cycle.

Consumer staples are defensive, representing companies whose business performance is not closely tied to the health of the economy. Technology stocks are cyclical, tending to do well when economic growth is strong, and energy stocks are a “late cycle inflation hedge,” writes Stovall.

“The most attractive aspect of energy stocks are their valuation,” said Talley Leger, the founder and investment strategist at Macro Vision Research, who spoke on a recent panel at the Global Macro Conference in New York. “Oil stocks are trading at a 35% discount to the market … [but] we don’t have a catalyst yet”  to possibly move those stocks higher.

In the meantime, he said, oil company sales are depressed because of the sluggish global economy. “Investors hunting for value in the energy sector should be patient.”

Oil prices are trading near $60 a barrel, having recovered from just under $44 in March. But a year ago they were trading near $107 a barrel. Many oil companies “are still losing money,” Leger said. “Things are improving, but we still have a ways to go before these companies are profitable.”

In general companies involved in fracking, which tend to be smaller and with heavier debt loads, are the most vulnerable while refiners are the least because they benefit from the cheaper crude oil that they refine into products like gasoline and heating oil. But “if oil prices continue to appreciate, down the road…that will benefit the integrateds,” said Leger, referring to the big oil companies like Exxon Mobil (XOM) that integrate exploration and production with refining.

“Shale broke the demand-led supercycle” for oil, said Aakash Doshi, vice president of commodities research at Citigroup Global Markets, who shared the panel with Leger.  He doesn’t expect oil prices will reach $75 a barrel until the end of next year or the following year.

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