Top-performing energy stocks may still be a buy based on their charts and earnings power

Published Thu, Oct 13 20229:56 AM EDTUpdated Thu, Oct 13 20221:25 PM EDT

Patti Domm @in/patti-domm-9224884/@pattidomm

Investors have been pulling money out of top-performing energy positions this year and putting it into the technology sector, but some analysts say they may be moving out of oil and gas companies too soon. An ETF that mirrors the S & P technology sector has fallen 33% this year, while the exchange-traded fund representing the energy sector is up 45%. So, Strategas analysts find it curious that the Technology Select Sector SPDR Fund (XLK) has seen inflows of $244 million this year, while the outperforming Energy Select Sector SPDR Fund (XLE) has seen $584 million in outflows. "Even over the last year, $2 billion went into XLK and $700 million went out of XLE," said Todd Sohn, Strategas technical strategist. Energy is the only major S & P industry sector that is higher for the year. On top of that, Strategas found that the energy sector is punching above its weight when it comes to earnings power. For instance, its 12-month trailing earnings weight among S & P 500 companies is more than double its S & P 500 market cap weight of about 5%. Sohn said the sector, therefore, could see valuations rise to the point where they are closer to 10% of the S & P 500 market capitalization. In the past 50 years, the sector has traditionally been about 11% of the S & P 500, he said. S & P energy earnings are expected to soar 121% in the third quarter, while total S & P 500 earnings are expected to grow just 4.1%, according to Refinitiv. Technology companies are expected to see an earnings decline of 3.5%. Based on the energy sector's charts and fund flows alone, Sohn said energy still looks like a buy, including the biggest market cap companies, such as Exxon Mobil , Chevron and ConocoPhillips. Investors also need to consider that the price of crude oil could be a wild card for the sector, and it is driven by macroeconomic and geopolitical forces. Oil is off its highs for 2022, but it could rise if supplies become constrained. It could also fall if there is a recession and demand drops. West Texas Intermediate crude futures rose to about $130 per barrel when Russia invaded the Ukraine earlier this year but since then fell back to the mid-$70s. On Wednesday, WTI futures were at about $87 per barrel. From a chart basis, Fairlead Strategies founder Katie Stockton said West Texas Intermediate oil looks set for a push higher before returning to the recent lows. In a note Tuesday, she wrote: "We believe the rally will resume after a shallow pullback, based on improvement in our intermediate-term gauges, with a move in the high-$90s/bbl. likely before the loss of long-term momentum resurfaces, supporting an eventual return to the recent lows, which put short-term support near $76/bbl." Sohn said it may be that investors took profits in energy stocks too soon, or they were paring back energy holdings as the sector gained due to ESG (environment, social, governance) investing considerations or a distrust of the sector. "The other reason could be that people may feel it's up a lot and they missed the move. They're wary to get involved here," Sohn said. The energy sector had been shunned by many investors, but companies have cleaned up their balance sheets and have been more disciplined about expanding drilling operations than in past cycles. "We're in a much different cycle. We're not dealing with zero interest rate policies anymore," said Sohn. "We have a [Federal Reserve] that is set on clearly tightening to stomp out inflation. That benefits energy. It's the wrong environment for growth, and the right environment for value, and energy would fit the bill for that." The energy ETF is up 11.2% in October, while the S & P 500 is up just 0.2% and the technology sector ETF is off 1.9%, through Wednesday's close. "Energy has by far the best trends of all the sectors," said Sohn. The XLE closed at $80.12 Wednesday. But if it could return to the $92 level, the high of the year, the charts point to a possible level of $97, the high from 2014. "It's one of the few areas that hasn't made a new high in the last eight years. The last significant high it made was in 2014," he said. Sohn said Exxon's chart looks particularly appealing. The stock retested its 2014 high briefly in June, and if it could return to the $105 level that would be a big positive. "It's a significant breakout if you could get to that level," he said. "It would pull the XLE with it because it's 23%" of the sector. "It's the Apple of energy," he said.

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