Energy is the top-performing S & P 500 group for the month and year, but Fundstrat's Tom Lee believes there's "plenty of upside" ahead for the sector on the heels of rising oil prices. In a Monday evening note to investors, Lee said energy remains his top sector pick, and he continues to favor his basket of so-called epicenter stocks. These are names that were hit hardest by the Covid-19 pandemic, such as airlines, restaurants and retailers. Brent crude jumped above $80 per barrel on Tuesday for the first time since October of 2018, while West Texas Intermediate crude futures climbed to a more than two-month high. Each contract is now up more than 50% for 2021. Lee pointed to three factors that he believes will continue to push crude prices higher: capital availability has declined — leading to structural shortages — the White House's stance against new exploration means less supply and a strong economic recovery could lead to a demand surprise. He noted that the above factors are also good for energy stocks, which despite being the top-performing S & P group this year have lagged the performance of oil itself. Oil is 14% above its pre-pandemic level, while the Energy Select Sector SPDR Fund and VanEck Oil Services ETF are 12% and 24% below their respective pre-pandemic levels, according to Lee. "These are sizable performance gaps," he said, noting this would be justified if energy companies were worse businesses. Instead, free cash flow margins for the business are up from 5.46% in 2018 to 7.64% today amid capital discipline from the sector. "We think there is a strong fundamental case to be long energy equities. Thus, we continue to view this as our favorite sector into [year-end]," he wrote in a note to clients. He added that consensus is shifting from negative to positive on the sector for the first time. Oil hitting new highs is bullish for epicenter stocks as a whole since since it indicates the economy is continuing to recover. Lee noted that betting on the epicenter stocks has been painful since the end of June when the Covid delta variant took hold, leading to new lockdowns and a drop in consumer confidence. But the group has the potential for positive surprises in the fourth quarter, due to factors including cost disciplines and a demand recovery. Fundstrat is far from the only firm that's bullish on energy stocks. Goldman raised its year-end Brent forecast $90 per barrel from $80 , while BMO said that "the oil market is in the early stages of a multi-year upcycle." "I still think you can buy them," CNBC's Jim Cramer said Tuesday on "Squawk Box" about energy stocks. "You can literally buy almost anything in this group. It still works."
The sun is seen behind a crude oil pump jack in the Permian Basin in Loving County, Texas.
Angus Mordant | Reuters
Energy is the top-performing S&P 500 group for the month and year, but Fundstrat's Tom Lee believes there's "plenty of upside" ahead for the sector on the heels of rising oil prices.