Today’s Data section is all about the US Energy equity sector, with 3 points about large and small cap stocks in this space.
#1: Starting with a telling fact which also helps frame the broader discussion: from 2012 to 2021, the US large cap Energy sector was either the worst or second-worst performing group in the S&P 500 in 7 of those 10 years.
- Years where Energy was the worst performing group: 2014 (-7.8 pct), 2015 (-21.1 pct), 2018 (-18.1 pct), 2019 (+11.8 pct), and 2022 (-33.7 pct).
- Years where it was the second-worst group: 2012 (+4.6 pct) and 2017 (-1.0 pct).
- In the other 3 years, Energy underperformed in one (2013, +25.1 pct vs. +32.4 pct for the S&P) but was the BEST performing sector in two (2016, +27.3 pct vs. +12.0 pct and 2021, +54.6 pct vs. +28.7 pct).
While there are many industry-specific reasons for this horrible long-run performance, a simple chart of WTI oil prices tells the story well enough. The chart of crude prices from 2012 – 2021 below shows:
- Crude prices have gone nowhere for a decade, which limits sector earnings power and leads to the long string of underperformance noted above.
- The only times Energy outperforms the S&P is when oil prices bottom and move solidly higher (2016, 2021).
- Energy can be a reasonable money maker if crude prices reach a high plateau (2013) even if the group still underperforms.
Takeaway: large cap US Energy stocks have exhibited feast (rarely) or famine (usually) returns for the last decade because the underlying price of their benchmark commodity has been volatile and trendless. This limits the periods when these companies can produce meaningful upside earnings surprises to those times when oil prices suddenly start to increase after a steep drop. That’s exactly what is happening now, of course, and Energy is the only S&P 500 sector up on the year.
#2: Because of this chronic underperformance, Energy’s weighting in major US equity indices has declined to near trace-element status:
- S&P 500: 3.7 percent weighting to Energy, less than Apple (6.9 pct), Microsoft (6.0 pct), Google (4.2 pct), and basically the same as Amazon (3.6 pct).
- Also, no US large cap Energy company has even a 1 percent weighting in the S&P 500. Exxon (0.9 pct) and Chevron (0.8 pct) come closest, but even their combined weighting still falls shy of a Tesla (1.9 pct). As big a fan as we are of disruptive innovation, very few people “need” a Tesla but the US would come to a grinding halt (literally) without Exxon and Chevron.
- S&P 600 (Small Caps): 5.8 percent weighting to Energy. No single name has even a 1 percent weight, with Range Resources and Matador at 0.6 pct and 0.5 pct respectively as the largest Energy-related allocations.
- Russell 2000: 5.8 pct Energy weighting. Chesapeake is the top name in this index, with a 0.3 pct weight, but meme stock AMC is still at a 0.4 pct weight.
To put some perspective around these numbers, consider that back in 2011 Energy’s weighting in the S&P 500 was 12.6 percent (3.4x today) and in the Russell 2000 it was 6.7 percent (1.2x today). This was the last time there was any real bullishness about oil prices remaining high for a protracted period. The reason back then was the remarkable growth of the Chinese economy through and after the Financial Crisis, with a commensurate increase in the country’s demand for oil.
Takeaway: even with recent price gains, US Energy stocks remain well below the relative market values they reached during the last period of prolonged, high oil prices. Notably, both large and small cap Energy sectors are now just as profitable as they were from 2011 – mid-2014 (see link to S&P spreadsheet below). The missing piece of the valuation puzzle is, of course, how long they can keep generating similar profits.
#3: That last issue about the sustainability of corporate profits brings us to our final point, namely the stability of oil prices over the very long run. The chart below shows WTI crude prices from 1987 – present and notes how these informed the Energy sector weighting in the S&P 500:
- When oil prices were generally stable, from 1987 to 2000, large cap Energy underperformed dramatically.
- From 2000 – 2008 oil prices more than tripled and Energy stocks outperformed by a wide margin.
- From 2011 – 2014 oil prices were stable at high levels and often over $100/barrel, Energy stocks held their own.
- From 2015 – 2021, oil prices dropped, and Energy stocks massively underperformed (as noted in point #1).
Takeaway: it will be far better for Energy sector stocks if oil prices slowly grind higher and hold those gains than if we get a quick spike to $125/barrel, say, but that proves unsustainable. That may sound like a facile observation, but it is grounded both in solid fundamental analysis and the sector’s very difficult investment history. This group verges on uninvestable when oil prices are stable (1987 – 2000) and goes well over that line when prices fall (2015 – 2021). In other words, it has earned its paltry index weighting by being tied to a volatile and unpredictable commodity price. We are optimistic that macro factors (industry underinvestment, ESG limitations, good future global economic growth) will support both energy commodity and stock prices. We just want to see that story develop over 1 to 2 years, not 1 to 2 weeks.
S&P Historical Sector Earnings Spreadsheet (click “Additional Info”, choose “Index Earnings”): https://www.spglobal.com/spdji/en/indices/equity/sp-500/#overview