Energy stocks: Getting ready to buy a big dip

A new oil well head waits to be fracked at a Hess site near Williston, N.D.
Andrew Cullen | Reuters
A new oil well head waits to be fracked at a Hess site near Williston, N.D.

No one can be sure how far oil will fall before it bottoms, but investors soon are likely to begin picking their spots and buying up beaten-down energy stocks.

Companies on the S&P 500 that make up the sector collectively have lost 7.3 percent in 2014 and in fact are the only loser of the index's 11 broad groupings. The damage is even worse in some subsectors, with oil and gas drillers plunging 43.1 percent and exploration firms losing more than 10 percent. Small-cap energy companies in the S&P 600 energy sector are off about 35 percent.

The decline in energy stocks has come with free-falling oil prices that have seen West Texas crude drop nearly 30 percent.

While most experts agree that the decline has strong fundamental roots—stagnating global growth and competition from shale and other sources—history suggests energy companies can't stay down forever.

When the sector has fallen to similar relative strength levels in the past, the ensuing 12- and 24-month periods have seen rebounds that are often violent, according to research from Sam Stovall, chief U.S. equity strategist at S&P Capital IQ.

Buying into the Bakken
Buying into the Bakken   

Stovall found that there have been six prior instances when energy stocks hit similar relative strength levels, and in five of those instances the return over the next 12 months was positive, with the only negative being a negligible 0.1 percent loss. The average gain was 13.45 percent, which was just shy of the S&P 500's performance.

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The results were even more dramatic for small caps, with energy shares outpacing their benchmark by 24.2 percent in the year after and 81 percent in the following two years.

"Understandably, some energy investors are wondering if they should just cap their losses and walk away while they still have some money left. Opportunists, on the other hand, are likely thinking that now is the time to start buying," Stovall said in a research note. "The significant underperformance of these energy sector indices relative to their benchmarks over the past 20 or 25 years may offer more reason to be constructive than destructive of their energy holdings."

The biggest challenge for investors, then, may not be if they should start taking advantage of the selloff in energy stocks, but when.

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Jim Paulsen, chief investment strategist at Wells Capital Management, warns against trying to call a bottom in oil, but said investors should consider a reasonable price range and then start at least nibbling.

"If you draw a big circle on where and say, 'I'm going to start accumulating,' you're going to feel pretty good about that over the next few years," he said in an interview. "I think we're in a trading range and probably will be for years. I don't know where the low end of that range is, but I think we're close."

He advocated that investors should "start accumulating on big downs," on the belief that the global economy will recover next year on the heels of aggressive central bank interventions, pushing demand higher.

Jeff Saut, chief investment strategist at Raymond James, recommends a cautious approach but one that does include wading into the sector.

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"While crude oil may be making a bottom, it is tough to see how many of the energy stocks can get much more than a 'dead cat bounce' now that we are entering tax loss selling season," Saut said in a note. "I do think some of them represent excellent value, but at this time of year people sell things for tax reasons without much regard to the fundamentals. Consequently, I would make a shopping list and look to scale into select energy stocks between now and year's end."

Elsewhere, Goldman Sachs remains neutral on the sector broadly but favors refiners and pipelines specifically. Among the companies on its conviction buy list are Kinder Morgan, MarkWest Energy Partners, Plains GP Holdings, Targa Resources and Tesoro.

Larry Pitkowsky, portfolio manager at the $436 million GoodHaven Fund, said he has added to positions in WPX Energy, which has crumbled 51 percent over the past three months. Pitkowsky said he is impressed with the company's new CEO, Rick Muncrief, as well as the allure of picking up a beaten-down company with brighter prospects ahead.

"We are always attracted to areas that are under stress, because that's where you find the best bargains," Pitkowsky said. "We always look where there is panic selling and negative headlines."

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