Energy sector short-covering will 'rip people's faces off'

Investors betting on a fall in shares of energy companies could have their "faces ripped off' if oil prices continue their recovery, a money manager told CNBC.

Oil prices have recovered in recent sessions to trade near $40 a barrel since hitting their lowest levels in over a decade earlier this year

While some investors are predicting that market expectations for oil at $50 a barrel might be too fast, and too soon, Bill Smith, chief investment officer and senior portfolio manager at Battery Park Capital, told CNBC the energy sector will find equilibrium by the second quarter of 2016. And it will not be pretty for those holding bearish trades.

Speaking to CNBC's "Squawk Box", Smith said if indeed oil prices stabilize, much-battered energy stocks will follow crude prices higher.

"It's going to be a short covering rally that rips people's faces off," said Smith. "It's going to be ugly."

Battery Park Capital has assets under management worth $340 million.

Short-selling refers to selling an asset in the hope of buying it back at a lower price later.

A pump jack operates at a well site leased by Devon Energy Production Co. near Guthrie, Oklahoma.
Nick Oxford | Reuters
A pump jack operates at a well site leased by Devon Energy Production Co. near Guthrie, Oklahoma.

The recovery in oil prices has been supported by reports suggesting that oil producers are planning to work together to reduce excess supply in the market.

Earlier this week Reuters, citing New York-based oil industry consultancy PIRA, reported major OPEC producers were discussing a new price equilibrium of around $50 a barrel.

Broadly, Smith was less upbeat about the U.S. economy. He said while the economy wasn't heading into recession, it wasn't growing either.

"We don't have the building blocks to bust out and go on a growth trajectory," he said, adding there's no reason for runaway inflation at this point in time.

Government data showed core inflation rose 1.7 percent in the 12 months ended in January. The U.S. Federal Reserve's inflation target is at 2 percent.

But Smith said he doesn't see any reason why the Fed would raise interest rates just yet, even due to currency risks.

Last December, the Fed raised interest rates from near zero percent for the first time since 2006. Following the rate hike, the dollar initially found strength against major currencies around the world before losing some momentum earlier this year. But the move also created a major sell-off in global stock markets in January.

The Federal Open Market Committee is due to meet next on Mar. 15 - 16.

Smith said, "Every time they even talk about raising rates, the dollar rips higher and it's just creating chaos globally. So, I would much rather see them sit on the sidelines now."

— Huileng Tan contributed to this report.

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