The market's worst-performing sector is about to rebound, top strategist Lee predicts

Key Points
  • The energy sector is a key driver for a rebound in value stocks, says Fundstrat's Tom Lee.
  • Lee identified several signs that the worst-performing energy sector may have bottomed.
  • The oil price recovery appears to be intact and energy stocks are trailing other key equities.
Workers operate a drilling rig for an EBR Energy LP natural gas well near Columbus, Texas.
Scott Dalton | Bloomberg | Getty Images

Energy stocks may be bottoming as a number of bullish historical signals herald a potential reversal for the worst-performing S&P 500 sector this year, according to Tom Lee of Fundstrat Gloabl Advisors.

Energy stocks are currently a "style orphan" because they are not cheap enough for value investors and aren't delivering enough upward momentum for growth investors, the closely followed Wall Street bull said in a research note on Friday.

However, Lee is monitoring the energy sector for signs that a value recovery has reached "escape velocity." The S&P 500 Energy sector is down more than 9 percent this year while the S&P 500 is up more than 12 percent.

"After all, by definition 'Value' is equity cheap relative to intrinsic value, and Energy stocks are the poster child, especially if oil is recovering," wrote Lee, managing partner and head of research at Fundstrat.

The shape of the so-called futures curve suggests that oil supplies are tightening after three years of oversupply that has weighed on crude prices, Lee notes. To be sure, U.S. West Texas Intermediate crude oil for immediate delivery is still cheaper than prices for WTI shipped in the upcoming months. But prices for oil contracts dated after February begin to plateau early next year and drop after that.

WTI crude futures curve, source: Factset

This structure signals that the oil price recovery is intact and "Almost always drives a rally in Energy equities," Lee writes.

To be sure, the market is heading into a period that sees U.S. crude prices decline more often than not. On Monday, both U.S. crude and international benchmark crude were sharply lower.

However, Lee sees other signs of an energy rebound. Energy stocks are trailing materials to a degree that has marked a bottom for the sector in three periods in the past.

U.S. stocks in value sectors like consumer staples, telecommunications and energy have also underperformed their global peers in the MSCI World Index, another reason to expect value names to outperform, Lee said.

Out of 27 energy stocks that Fundstrat examined, it identified 11 names with a bullish outlook. Some of the stocks that ranked favorably in both its quantitative and technical analyses are Pioneer Natural Resources, Concho Resources, EOG Resources and ConocoPhillips.