JPMorgan calls energy stocks 'highest conviction' trade, sees rally continuing

Published Thu, Apr 28 202210:53 AM EDT

Energy stocks are far and away the top-performing S & P 500 group this year, and yet JPMorgan believes the trade is just getting started. The firm reiterated its bullish stance Thursday, calling the sector its "highest conviction" overweight recommendation. The sector has faced some weakness recently and is down 2% in April. But for 2022, energy stocks are still up 34.6% through Wednesday's close. The second- and third-best sectors are staples and utilities, which are up 2% and 1.5%, respectively, for the year. Energy is also the best-performing sector over the past year following a surge in oil and gas prices. The outperformance follows years when the sector posted lackluster returns. Still, the recent surge has been extreme, raising questions of whether this size rally can continue. JPMorgan's bull case centers on forecasts for rapid earnings growth and multiple re-ratings as demand for fossil fuels continues to rise at the same time as supply remains constrained. "The supply-demand balance continues to be tilted in favor of improving demand with higher commodity prices while supply growth should remain impaired by ESG policies and rising cost of capital," the bank's strategists led by Dubravko Lakos wrote in a note to clients. JPMorgan predicts that energy demand will outstrip supply by 20% by 2030, requiring north of $1 trillion of incremental capital to close the gap by the end of the decade. "While investor interest and sentiment has clearly inflected from record lows over the past year, energy stocks are far from pricing in strong and sustainable outlooks for fundamentals and shareholder return," the bank added. Years of lagging performance for energy stocks means the sector now accounts for just 4% of the S & P 500. Lakos noted that this is well below the 20-year average of 8% and down from 2008's peak of 16%. He added that energy looks especially attractive against a macro backdrop of geopolitical tensions and inflation since it's a "direct input into every segment of the economy and a natural hedge." Lakos noted that the group currently trades at 9.5 times forward earnings, significantly below prior levels, despite the fact that companies are cutting spending and growing margins. As energy companies post the highest earnings in years, JPMorgan said the group now looks "highly attractive" from a value, growth and quant perspective. "[F]undamentals and valuation make a compelling case for the sector and we expect dips to be bought from [a] broadening investor base including energy companies revamping share repurchases," the firm said. Drilling down within the sector, Occidental is the top-performing stock this year, gaining about 90%. Marathon Oil , Coterra Energy and Halliburton are all up at least 50%. Oneok and Phillips 66 are the two worst-performing components this year, but are still up 11% and 15%, respectively. - CNBC's Michael Bloom contributed reporting.

A self-elevating drilling platform, or jack-up drill rig, is seen at a shipyard of Cosco (Nantong) Shipyard Co., Ltd before being delivered to China Oilfield Services Limited (COSL) on July 13, 2021 in Qidong, Nantong City, Jiangsu Province of China.

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