There are a couple of reasons I think Energy remains the key to this market and the key to 2016 S&P 500 earnings, and why I’m more positive than most:
- Energy is still a 5%-6% market cap weighting in the S&P 500, bigger than Basic Materials by 2(x) and far bigger than the “ex-Chemical” Basic Materials weighting (meaning copper, aluminum, gold, silver, i.e. industrial and precious metals weighting), thus of all the “commodities” crude oil remains the most important commodity.
- Forward Energy estimates for 2016 have started to turn positive which surprised me when I looked at the data this morning.
- With consensus Street estimates expecting a 27% decline in Energy revenue in Q1 ’16 and a 103% drop in Energy sector earnings (Thomson data source) just from a sentiment perspective it is hard to think that the earnings and revenue estimates revisions get much worse.
- High-yield looks to have bottomed with crude oil, and the Financial sector—particularly the big banks—have undoubtedly felt the weight of the regulators on their Energy loan books, as we have written previously on this site. The point being that if crude bottoms, the Energy sector doesn’t see the expected default frequency and severity expected, then that takes some of the pressure off the Financials, particularly if the regulators forced the banks to write down the loan books too much.
The point is that if crude oil and Energy turn is sustainable, the S&P 500 makes all-time-highs. Remember, the S&P 500 has basically been flat since crude oil peaked in August ’14. The 2,134-2,135 peak prints in the S&P 500 in mid-2015 were new all-time highs, but the S&P 500 has basically gone nowhere since late 2014.
Energy estimates: how are revisions faring ?
While the data will be more meaningful after looking at the full month of April ’16, here is how forward Energy estimates have fared in the last week:
- Q1 ’17: not available
- Q4 ’16: +14.2% vs +11% just one week ago
- Q3 ’16: -53.9%, vs -54.7% just one week ago
- Q2 ’16: -76.6% vs -77% just one week ago
- Q1 ’16: -103.3% vs -101.9% just one week ago
Again, a 1-week time period is too small to get really excited about an Energy sector earnings turn, but there haven’t been too many time periods since the Spring of 2015 where forward Energy sector earnings growth improved at all. The other plus is that Energy is facing very easy compares over the next 8 months in terms of y/y gains.
Readers will be updated on how 2nd half Energy sector earnings and revenue growth develop.
Technical analysis:
Bespoke published a great crude oil chart on Friday, April 8th that readers need to see. Crude oil bottomed in the $42-$43 area in 2015, before taking the one final leg lower to $26 in late ’15, early ’16.
$42 is also where crude peaked in mid-March ’16. A trade through $42-$43 and Energy gets new life, in my opinion. At worst, I don't think we see $26 for a while either.
Conclusion: I think the Energy sector remains the key to this market, and I believe we’ve seen the lows for the sector. Clients probably have their largest Energy weighting in years at 4%-5% of their accounts (depending on the client, size of the account, etc.), and that weighting could grow, but readers can also play the sector and commodity bounce through Emerging Markets, (Vanguard FTSE Emerging Markets (NYSE:VWO), iShares MSCI Emerging Markets (NYSE:EEM)), which have horrible 10-year returns and also look to be stabilizing. Clients also own the VWO and EEM for the first time ever in the last 6 months. A weaker dollar and rising commodity prices would be a new tailwind for an asset class that has gotten truly trashed in the last 10 years. (Client positions can change at any time for various reasons.)
Energy companies don’t report in bulk until late April. Schlumberger (NYSE:SLB) and Halliburton (NYSE:HAL) will be the first reports the week of April 21, and then Exxon (NYSE:XOM) and Chevron (NYSE:CVX) report the very last days of April.