Strategist believes energy sector is at ‘peak negativity’
NEW YORK Earlier this year, Bank of Montreal chief investment strategist Brian Belski called energy stocks a value trap.
Now, he’s become more constructive on the space, upgrading the sector to market weight from underweight.
A confluence of factors influenced the strategist’s decision to “neutralize” his portfolio position for both U.S. and Canadian energy stocks. The first is that the sector has reached what he called “peak negativity,” underperforming the S&P 500 by the most since 1986, or the last supply-side driven crash in oil prices.
Second, a prolonged period of low oil prices is now baked into analysts’ earnings expectations — though some other Canadian analysts will probably have to ratchet down their estimates even further.
“Earnings per share revisions are one of our most trusted contrarian indicators and the fact that they have hit extreme negative levels is encouraging to us for sector performance prospects,” he wrote. “Energy sector growth expectations in Canada have come down significantly, but still remain too optimistic given the oil price outlook and especially when compared to estimates for the U.S.”
Finally, fund managers are underweight energy, in aggregate. To avoid missing a relief rally in the sector that would cause them to underperform their benchmark, they will be inspired to add to their energy holdings, Belski said.
However, the strategist is far from a full-fledged bull on the space, thanks to what he deems to be poor fundamentals and a difficult operating environment.
“Structural headwinds in the energy sector remain the main obstacle to any sustained outperformance,” he wrote, referencing strong U.S. production and flagging growth from emerging markets. “Despite the significant deterioration in energy performance, valuation remains significantly above average.”
Though he’s not pounding the table on energy stocks, this upgrade represents a noteworthy evolution in the thinking of a strategist who has cautioned investors away from the sector throughout the downturn in prices.
In December, he noted that his clients were consumed with picking the bottom in energy, and cautioned against holding on to the previous cycle’s winners. Two months later, he quipped that the short period of crumbling crude prices would not “cure a decadelong notion of oil and energy being the place to be.”
But the “pain trade,” Belski now says, is for energy stocks to move higher from here.