At the start of 2019, Energy stocks were a trendy pick. The feeling then was that the sector had been depressed too long and that a reversion to the mean at the very least would make the sector a winner in the upcoming year. So much for that…In fact, while energy has at least shown some gains this year, it has been by far the worst-performing sector in the S&P 500. The next worst is healthcare, with nearly three times the return of energy.
Now that we are all thoroughly depressed, the next question is will 2020 be better?
To answer that you have to look at the reasons for the poor returns in 2019.
The most obvious is the price of oil, but over the year, that doesn’t explain everything. WTI closed last year at around $45 and is now around $60, having spent most of the year ranging between $50 and $65. On that basis, energy stocks should be significantly higher than they are now. Still, rising oil would definitely help the sector, so what are the chances of that?
Well, OPEC+ still seem committed to limiting output, which will help. More importantly though, the cuts in capex by U.S. energy companies that have been such a feature of this year may well begin to have an effect. Less investment means slower production growth, so the shale boom that has kept oil low should at least slow, if not come to an end.
Far more influential, however, has been pessimism about global trade. With the trade war between the U.S. and China not…
At the start of 2019, Energy stocks were a trendy pick. The feeling then was that the sector had been depressed too long and that a reversion to the mean at the very least would make the sector a winner in the upcoming year. So much for that…In fact, while energy has at least shown some gains this year, it has been by far the worst-performing sector in the S&P 500. The next worst is healthcare, with nearly three times the return of energy.
Now that we are all thoroughly depressed, the next question is will 2020 be better?
To answer that you have to look at the reasons for the poor returns in 2019.
The most obvious is the price of oil, but over the year, that doesn’t explain everything. WTI closed last year at around $45 and is now around $60, having spent most of the year ranging between $50 and $65. On that basis, energy stocks should be significantly higher than they are now. Still, rising oil would definitely help the sector, so what are the chances of that?
Well, OPEC+ still seem committed to limiting output, which will help. More importantly though, the cuts in capex by U.S. energy companies that have been such a feature of this year may well begin to have an effect. Less investment means slower production growth, so the shale boom that has kept oil low should at least slow, if not come to an end.
Far more influential, however, has been pessimism about global trade. With the trade war between the U.S. and China not only continuing but actually intensifying, that pessimism has been growing. This year has been marked by a feeling that things are just about to blow up, but so far, that hasn’t happened.
If anything, the evidence over the last few months suggests that quite the opposite is happening. The two countries most affected by the disruption seem to have shrugged it off. U.S. stocks are once again setting record highs, and, after bottoming in August, the iShares China Large Cap ETF (FXI) has gained thirteen percent in recent months and is only around five percent off its 52-week high.
Given that, there is an increasing feeling that neither side is really incentivized to end the dispute. Politically, Trump feels that tariffs are a winning issue for him and from the Chinese perspective, a lot of economic issues can be excused when the blame can be laid at the door of America for starting all this. I am not, therefore, in the “it will all be over soon” camp, but increasingly in that which says that it doesn’t matter as much as we thought it would.
That is an increasingly common position, so we will go into the year with positive sentiment about growth, and therefore energy. For that sentiment to result in actual gains in the sector though, all of the above has to translate into more profit for energy companies. If, as expected, oil prices hold up better in 2020 than they have this year, the reduced capex costs combined with already high production levels should make that happen.
The logical conclusion is that the confidence that many had going into this year that the energy sector could do well was not so much misplaced as mistimed, and 2020 could well be the year that the sector shows significant gains and closes the performance gap.
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