Goldman’s clients are asking about oil prices, and particularly about the read-through of recent increases for equities.
While not an especially novel observation, one implication of higher oil is that energy shares should do well, or at least relatively well. That ostensibly intuitive assumption didn’t hold this week, when energy stocks were lower with everything else, but they outperformed the broader market in eight of the preceding nine weeks, and in 10 of the preceding 12.
Brent’s up some 28% over the past three months even after pulling back a bit. Goldman’s commodities team lifted their 12-month forecast to $100 on OPEC+ supply curbs and a better demand outlook, which together should “more than offset” higher US supply.
Not that it matters (because if we’re honest, out-year forecasts for markets and macro are about as useful as month-ahead weather forecasts), Goldman expects Brent to be relatively range-bound through 2025 between $80 and $105. If that’s even a semblance of accurate (and again, it’s not a comment on Goldman’s forecasting abilities to gently note that the range for WTI looking back to early 2020 is negative $37 to positive $124, suggesting two- and three-year forecasts are perhaps worse than useless), then the bulk of the upside is behind us.
Still, energy shares may have some gas left in the tank. It’s not an absolutely perfect fit, but energy stocks do track the price of crude, and if you think the latter’s going back into the triple-digits, then shares of companies which produce it should rise around 4%. I’m laughing, and you are too, because that’s just one good week’s worth of upside, and therefore is scarcely worth mentioning.
So, why mention it? Well, because Goldman’s remarks fit well with similar comments from Morgan Stanley’s Mike Wilson and also with JPMorgan’s energy Overweight. The latter (JPMorgan’s asset allocation preference for commodities/energy) is predicated in part on geopolitical tensions and other big picture concerns, while Wilson’s relatively bullish view on energy shares is about stock fundamentals.
Goldman’s David Kostin, who doesn’t always agree with Wilson, seems to be on the same page vis-à-vis energy. “The sector trades at an FY2 P/E relative to the S&P 500 of 0.7x, ranking in the 5%ile versus the past 30 years,” he remarked, in his latest, adding that “the sector’s price/book multiple screens as low relative to its expected ROE, based on the relationship between valuation and profitability for other S&P 500 sectors.”
At the same time, energy companies are funneling cash back to stockholders amid record profits. The sector’s total cash return yield is 8.5%, Kostin noted. It’s 3.7% for the index. “The combination of low valuations, high shareholder returns and the outlook for firm oil prices suggests energy equities will outperform,” Kostin went on.
He did add one caveat: “We believe the upside will be modest in the near-term, as investors will have to balance the potential benefit to energy stocks from higher oil prices with the potentially higher recession risk due to the inflationary impact” of higher-for-longer crude.
I’ll take this opportunity to note that my own performance from the pandemic crash lows through 2023 is attributable almost entirely to a very large energy Overweight and an (exceedingly lucky) call on Meta last autumn. Some regular readers will attest to the veracity of those claims. I was public about my conviction in energy in 2020, and also about Meta’s prospects following the plunge 11 months ago. When paired with what, starting last year, was a very large allocation to T-bills, those two calls made for a very nice combination of medium-term benchmark outperformance and monthly income.
I’ve learned, over the years, to treat my own personal success as a contrarian indicator. When something’s going well, it’s time to hedge. That’d be my caveat: Energy worked, Meta worked and cash yields go up every few months, so an oil crash, a Meta stumble and a Fed about-face must be just around the corner. I’m just joking. Sort of.
So what’s your next move?
I will attest to the oil, meta calls. H is the GOAT y’all.
I followed my leader into energy and the bills. Thank you, thank you, thank you…….If you need a kidney, give me a call.
We often forget that higher crude prices are a double-edged sword for the integrated producers, such as XOM, which produce chemicals and other products from part of their crude and natgas output. I’d guess that the integrated producers carry more weight in the sector indices?
While traditional energy companies may be up, alternative energy yieldcos are way down, as are some solar energy-related manufacturers. The yieldcos are interest-rate sensitive, so if we believe that interest rates are going down in a year or two, then adding more of these at current prices not only locks in high yields, but also could see some capital appreciation. Regarding treasury bills and notes, it is tempting to buy 5-10 year notes at current yields, with the plan to sell them if rates drop, for some capital gain and in order to buy stocks (which might have dropped due to recession). Or just hold the notes if that’s how things work out. >4% with some tax advantage isn’t bad.
H-Man, it seems there is more downside risk to oil than upside if you assume the global economy is running out of gas. I will leave it there.