Besides USD cash, commodities are the only asset class that’s worked in 2022.
Everyone can recite the stocks story, and global bonds fell into their first bear market in at least three decades this week.
Looking out across assets, one finds commodities up 35%, cash up 0.4% and nearly everything else mired in a deep slump.
2022 is (easily) the worst year for a cross section of popular assets since 2008 (figure above). I suppose this goes without saying, but losses in 2018, near the end of the Fed’s last tightening cycle, were nowhere near as deep as this year’s declines for credit and equities, never mind the gratuitous bloodletting in Treasurys.
Within equities, energy stands out. The S&P Energy index is up 41% in 2022 and 67% over the past year. If you think there’s no more gas left in the tank (forgive the bad joke), you may be mistaken.
The energy sector “remains in a particularly sweet spot with very attractive valuations, strong fundamentals and significant improvement in quality,” JPMorgan’s Dubravko Lakos-Bujas wrote, in a new note.
Remarkably, energy trades at a ~10x P/E discount to the market, Lakos-Bujas remarked. The figure (below) illustrates the point — and rather poignantly at that.
In simple terms: Energy shares have never been cheaper, even as energy itself has virtually never been more expensive.
Crucially, energy is enjoying an improvement in its style and factor rankings. That’s thanks in no small part to better fundamentals and momentum, and it presages inflows from smart beta funds. On JPMorgan’s estimates, quant- and smart beta-product rebalancing could mean some $20 billion in monthly inflows for energy.
“Unsurprisingly, energy policy is starting to become less restrictive as developed countries look to tackle the oil and gas crisis,” Lakos-Bujas went on to say, noting that based on JPMorgan’s meetings, “investors are increasingly becoming cautious and skeptical of their ESG allocations and frameworks due to continued underperformance.”
The bank isn’t alone in espousing a favorable view of the sector. In an interview with Bloomberg, BlackRock senior investment strategist Kurt Reiman said oil and gas companies are likely to outperform despite an otherwise gloomy outlook for equities. He called the war in Ukraine “a supply shock within a supply shock.” Reiman also flagged underinvestment, and the lag in bringing new capacity online.
Last month, Texas’s Republican state comptroller put BlackRock on a list of financial firms that “boycott energy companies.” Glenn Hegar, the comptroller, wasn’t generous. “The environmental, social and corporate governance movement has produced an opaque and perverse system in which some financial companies no longer make decisions in the best interest of their shareholders or their clients, but instead use their financial clout to push a social and political agenda shrouded in secrecy,” he said, citing “research.”
Hegar was especially vexed at what he called “the use of doublespeak by some financial institutions as they engage in anti-oil and gas rhetoric publicly yet present a much different story behind closed doors.”
I’ve been very overweight energy since early 2021. Back then, almost every energy name looked very undervalued, on consensus estimates that looked clearly too low, even assuming negative terminal growth. My picking was ok but it didn’t matter, everything worked.
Today, the typical energy name looks overvalued, on consensus estimates that don’t look clearly too low or too high, assuming terminal growth flat. To get undervaluation, I usually (not always) need to assume oil holds above $70 through the forecast period (to 2026) and terminal growth is slightly positive. That’s possible, I guess, but doesn’t feel like the no-brainer of early 2021.
Nevertheless, I’m still overweight energy.
I’ve narrowed down to US gas exposure (thesis of growing LNG -> US gas becomes globally taxable -> new floor for Henry Hub in mid single digit $), European gas exposure (thesis of permanent turn away from Russian gas -> LNG + renewables + nuclear + conservation can’t meet demand -> EU won’t totally screw up market pricing), and one European oil major that has underperformed badly (you can guess which total dog this is).
As for generic exposure to oil price, I’m sympathetic to the thesis of peak oil supply + constraints in renewable ramp -> prices higher for longer, and encouraged by declining storage, recovering demand, the end of SPR releases, and OPEC+ action, but those are fundamentals for physical oil, while in the short term financial oil feels vulnerable to recession fear. So I’m mostly on the sidelines. Yeah, I’m an energy “tourist”, not a steel-nerved HODLer.