While global and US markets have endured a correction this year, one sector hasn’t participated: Energy. Global Energy stocks are up just over 30% year to date, and US Energy is up even more.[i] As you might expect, this is generating a host of chatter about a long-lasting leadership rotation, along with a hefty dose of fear of missing out—FOMO—among investors whose portfolios followed the broader market’s swings. Dear readers, let us issue a friendly reminder: You can’t buy past returns. Moreover, what just led isn’t guaranteed to keep leading. So if Energy’s run is tempting you to chuck a diversified portfolio for a concentrated position, take a deep breath, stay cool, and remember discipline is key to successful investing.
Whenever past performance makes you want to trade, we think it helps to pause and go back to basics. Remember one of the first principles of investing: Past performance doesn’t predict future returns. What happened one month doesn’t determine what happens the next. Just because something ran up bigtime doesn’t mean it will stay atop the leaderboard. Leadership shifts often. Sometimes those shifts are lasting, resulting in cumulative outperformance over a few years. Sometimes they are quick deviations—countertrends that burn out fast. If you chase them, you run the risk of missing returns if the hot sector turns cold.
For a recent example, consider Energy stocks last year. Then, as now, they were the hottest sector early on. When Q1 2021 ended, global Energy stocks were up 21.8% on the year, and US Energy stocks were at 30.9%.[ii] The MSCI World and S&P 500, by contrast, were up just 4.9% and 6.2%, respectively.[iii] According to headlines at the time, Tech stocks—and growth stocks in general—were out, and Energy and value were in. But the party didn’t last. Energy stocks were basically flat over the next several months and underperformed for much of the rest of that year.
Discerning a sentiment-driven countertrend from a fundamental leadership is one of the toughest tasks around. It requires clear thinking free of emotion. The task: understanding why a given category did well and assessing whether it is likely to last. In this case, we think Energy got a big boost from oil prices’ spike—in our view, a sentiment-driven reaction to Russian “President” Vladimir Putin’s Ukraine invasion and the risks many believed it posed to oil supply. As the US blocked Russian oil imports, European nations jawboned about doing the same and companies self-sanctioned, it drove fears of a severe global shortage. Headlines warned producers in the US, OPEC nations and elsewhere wouldn’t or couldn’t crank up production to offset Russia’s absence from global oil markets. The prospect of tight supply as the world ended Omicron restrictions—raising demand for oil—sent crude above $100. Since Energy companies’ earnings are oil price-sensitive, Energy stocks rallied in anticipation of a big boost to profits.
Thing is, this is all in the past. Stocks discount all widely known information lickety-split. If spiking oil prices and a global oil shortage are the crux of your reasons for loading up on Energy stocks now, you risk trading on widely known information that is already incorporated in Energy stock prices. Even if that thesis comes true, stocks move most on surprises. We are hard pressed to see much surprise power left in the prospect of $100-plus oil boosting Energy companies’ earnings.
Instead, we see a risk of disappointment. In our view, sentiment played a large role in oil prices’ spike—it seemingly stemmed more from fear of what might happen to oil markets than a realistic assessment of how oil supply and demand were likely to evolve. We are already seeing some indications that supply won’t be as tight as people presumed a month ago. Earlier this week, Bloomberg reported that India is stepping up its purchases of Russian oil.[iv] China, too, is reportedly buying.[v] When they buy more from Russia and less from Middle Eastern producers, it leaves the latter with additional supply to sell to the US and Europe. If you will pardon the industry jargon, oil markets are fungible—buyers and sellers are interchangeable. The more oil Russia is able to sell to the remaining nations and refiners willing to do business with a rogue state, the more non-Russian supply it frees up for the rest of the world to buy. As these trade relationships shift and adjust, it should help prices stabilize—especially as all the new wells drilled in the US over the past several months continue coming online and adding to production.
Yes, we have seen the many reports saying US Energy companies don’t plan to increase investment beyond what they have already budgeted for this year. But that doesn’t mean much—production was already set to increase under existing plans. The US Energy Information Administration forecasts US oil production rising to an average of 12 million barrels per day (bpd) this year and hitting a record-high 13 million bpd in 2023.[vi] While this forecast is widely available, based on our read of the Energy sector news coverage right now, it is also underappreciated, which suggests people loading up on Energy stocks now could be caught off guard by falling oil prices and weaker-than-expected earnings.
We get that Energy’s recent returns are alluring, but you can’t go back in time and get them. Moreover, even after its recent run, the sector is just 4.3% of MSCI World Index market capitalization—tiny.[vii] Owning some Energy stocks is likely beneficial for diversification, but we don’t think amassing a large overweight is likely to add much value over the foreseeable future. Energy’s time will eventually come, but it will probably happen when the sector is far less loved than it is today.
[i] Source: FactSet, as of 3/24/2022. MSCI World Energy Index return with net dividends and S&P 500 Energy Index total return, 12/31/2021 – 3/23/2022.
[ii] Source: FactSet, as of 3/24/2022. MSCI World Energy Index return with net dividends and S&P 500 Energy Index total return, 12/31/2020 – 3/31/2021.
[iii] Ibid. MSCI World Index return with net dividends and S&P 500 Index total return, 12/31/2020 – 3/31/2021.
[iv] “Cheap Russian Urals Crude Is Finding Willing Buyers in India,” Debjit Chakraborty and Serene Chong, Bloomberg, 3/20/2022.
[v] “China Is Quietly Taking Cheap Russian Crude as India Buys More,” Staff, Bloomberg, 3/23/2022.
[vi] “Short-Term Energy Outlook,” US Energy Information Administration, 3/8/2023.
[vii] Source: FactSet, as of 3/24/2022.
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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.