by Denise Chisholm, Director of Quantitative Market Strategy, Fidelity Investments
Many energy investors consider the group a “recovery play”, but history says the opposite. The sector typically lags the market when GDP growth accelerates (in the US or globally) and it lags even more when interest rates are falling. This slightly contradictory math to conventional wisdom happens because Energy most often zigs while the rest of the market zags. This time has been no different. Energy’s late 2022 peak profitability and returns happened when overall earnings growth was contracting by 10% (or was that one of the causes?). Fundamentals still look “solid” – ROE is top quartile, and capex/sales is bottom quartile – but that usually leads to underperformance, not the opposite.
Why? Because historically speaking, the rate of change is more important than the level for the relative performance of the stocks. The recent declines in profitability, and the increases in Capex (versus sales) have both been formidable headwinds for the sector, regardless of valuation. Starting points matter, and our current situation isn’t an advantageous one.
It’s also different this time. I analyze data from the 1960s, and two-thirds of those years have occurred during a secular decline in US Energy production. The mid-2010s shale driven production inflection is so steep compared to history that I should have shown it on a log scale. And even though rig count is much lower, and energy free cash flow is much higher, US production recently hit all-time highs - again. This illustrates just how productive current resources are.
If those efficiencies sound like good news for the stocks – they haven’t been. The bigger the production increase has been, the more likely the stocks lag the market. It doesn’t mean the price of oil falls – the commodity usually doesn’t. But it does usually mean the market has a lot more upside than the commodity itself. And this time may be no different.
This information is provided for educational purposes only and is not a recommendation or an offer or solicitation to buy or sell any security or for any investment advisory service. The views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. Opinions discussed are those of the individual contributor, are subject to change, and do not necessarily represent the views of Fidelity. Fidelity does not assume any duty to update any of the information.
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