Energy stocks posted the biggest gains of any sector in the S&P 500 Index last year -- and yet they still look cheap to Wall Street.
Spurred by an improving outlook for global demand and an agreement to cut oil production from OPEC and non-OPEC producers, analyst optimism for energy earnings jumped the most on record over the new year. This has made the shares inexpensive on a price-to-earnings basis.
The bull case for earnings hinges on a couple of factors. One, that the Organization of Petroleum Exporting Countries will honor its end of the bargain to cut production by 1.2 million barrels a day, keeping supply in-check. And two, that the new Trump administration will be lenient with energy companies after the appointment of former Exxon Mobile Corp. Chief Executive Officer Rex Tillerson as secretary of state.
"There's still some apprehension about the supply dynamics," said Alan Gayle, a senior strategist at Atlanta-based RidgeWorth Investments, which oversees about $40 billion. "Underlying demand is going to continue to increase as the outlook for the global economy continues to improve."
In 2016, the S&P 500 energy sector rose more than 23 percent compared with a 9.5 percent gain for the broader gauge. However, the money that poured into U.S. stocks after the election has since stalled, as investors assess whether the market ran too far.
This skepticism hit the energy sector especially hard. The stocks have been locked in a tight trading range since they fell 4.3 percent following a Dec. 13 peak. This has cheapened the shares faster than any other sector in 2017, as judged by their 12-month forward price-to-earnings ratio, data compiled by Bloomberg show.
Still, this remains a highly volatile market. Over the past year, crude prices have churned even the strongest stomachs, dropping as low as $26 dollars a barrel and then rebounding to near $50 a barrel.
Analysts, however, are not waiting to give the green light. While the price side of the ratio is slumping, earnings expectations are skyrocketing. Among analysts surveyed by Bloomberg, the 12-month forward estimate jumped from $3.76 a share to $17.32 in the new year, a more than 360 percent increase, the most since at least 1990. That compares to an 8.9 percent drop in the earnings estimate for the whole S&P 500.
Information for this article was contributed by Matt Turner of Bloomberg News.
SundayMonday Business on 01/22/2017