Investors should return to the "hated" but undervalued energy sector as the economy starts to grow again and oil prices turn higher, J.P. Morgan Chase strategists said Thursday.
The industry is poised to rebound amid a stampede out by institutional investors, with specific beneficiaries likely to be exploration and production companies, Dubravko Lakos-Bujas, the firm's chief U.S. equity strategist, said in a note to clients.
"We believe favorable technicals, improving fundamentals with stabilizing business cycle, and ongoing geopolitical tensions in the Middle East could help redirect flows into this universally hated and cheap sector," Lakos-Bujas wrote.
Energy has been the second-worst performer on the S&P 500 this year, returning just 5.3% versus the broader index's gain of about 19%. The $1.4 billion United States Oil Fund has seen $471.6 million in outflows this year, the third-highest of all commodity ETFs and about 25% of its total assets.
Dimming prospects for global growth have been a big factor in the sector's decline. Profitability has gotten hammered, with the sector expected to post a 28.7% year-over-year earnings decline in the third quarter, according to FactSet. Energy is now the second-smallest of the S&P 500's 11 sectors at just 4.6% of total market cap.
But J.P. Morgan foresees a turnaround in a sector it says is trading at a "multi-decade low" in price-to-book valuation.
The analysts think hedge funds and portfolio managers have turned too bearish on the group even as insider purchasing has surged and dividends and share buybacks increase. Energy's 3.7% dividend yield is easily the highest on the S&P 500.
"The sector should be a key beneficiary of stabilization/reacceleration in the business cycle, which we expect to start playing out by early 2020," Lakos-Bujas said.