Reversal in the Energy Sector

Friday, January 14, 2022

Over the past 10 years, no sector has been worse than the S&P 500 Energy sector. It has gained just 2.4% annualized over the past 10 years, the only sector without a double-digit return, and all of that return has come from dividends, as on a pure price return basis the sector is actually negative. But could that all be changing over the next decade?

As shown in the LPL Chart of the Day, the price of the energy sector is attempting to overcome a downtrend line that extends all the way back to the sector’s all-time highs in 2014. Not only that, but relative to the S&P 500, energy is on the verge of completing a long-term inverse head and shoulders pattern, a reversal pattern which suggests that last year’s outperformance could have more room to run.

In our recent Weekly Market Commentary, we used energy stocks as an example of why politics and investing don’t mix. Many expected energy to outperform during Donald Trump’s presidency due to deregulation (the sector fell 40% during his time in office) and underperform during Joe Biden’s presidency as democratic policies looked to shift toward green and renewable sources of energy. The energy sector is now up more than 40% since President Biden took office.

Now we believe that there are more forces at work than policies and politics, but many investors may have simply gotten the takeaway from those policies backwards. By allowing US companies to frack unencumbered, more deregulatory policies encouraged increased supply of oil which put downward pressure on oil prices. In contrast, more strict regulation reduces capex in the energy sector, which can decrease oil supply, and cause prices to rise.

At the end of the day, these companies are in the business of selling oil, and the stocks of the companies that have survived the last decade of declining oil prices tend to benefit when oil prices rise.

So can energy stocks continue to outperform after spiking 14% to start the year? According to LPL Financial Technical Market Strategist Scott Brown, investors shouldn’t rule it out. “We don’t believe investors need to chase the latest surge. However, the long-term breakout and overall technical picture suggest the path of least resistance is higher for both energy stocks and oil prices in 2022 and pullbacks are likely buying opportunities.”

One final potential tailwind for the group: the dollar. The US dollar has fallen 1% in the past week and appears to have reversed its uptrend from last year. As oil prices are denominated in dollars, a weak dollar may provide an additional boost to oil prices and energy stocks if it continues lower. Energy stocks still need to complete the inverse head and shoulders pattern by breaking through the “neckline” shown in the bottom panel of our chart. But a break through that resistance would target another leg of considerable upside versus the broad market.



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