As Sam Sees It: Overwhelmed Energy Investors Should Look to Technical Indicators

Sam Stovall  |

Each week, we tap the insight of Sam Stovall, Chief Equity Strategist for S&P Capital IQ, for his perspective on the current market.

EQ: The retail sales during the Black Friday and Cyber Monday periods disappointed expectations, which were optimistic because forecasts factored in lower gas prices as a driver for more consumer spending. Does this raise any flags on consumer strength going forward?

Stovall: Not really. What it does is raise questions about how valuable it is to tally up retail sales only on Black Friday and only on Cyber Monday. Now with Christmas music beginning to be played on radios constantly even before Halloween, I think what’s happened is much of the pre-Christmas sales has started well before Black Friday. So we’re really only going to know how well the retail sector did after the holidays have come to an end.

Looking at share price performance, however, I would say that investors of Consumer Discretionary feel as if they got a shot in the arm because there was an improvement not only in the absolute price of the sector, but also relative to the S&P 500. The index is now above both the 13-week and 26-week moving averages. I regard that as being a positive indicator for the sector.

EQ: Looking at oil prices, the recent slide has many experts making their own predictions. Some say we’ll see $60, some say we’ll see $100. How can investors make sense of what’s going on when they’re getting so much contradictory analysis?

Stovall: If you are an investor in the overall broad index, then I would say to ignore the volatility in your portfolio and ignore the commentary by these talking heads regarding what will either help or hurt economic growth in the quarters ahead.

If you are a forecaster of energy prices, meaning stocks within the energy sector, it’s another indication how difficult it is to forecast the price of oil. So you’re probably better off overlaying any kind of fundamental forecasts with technical opinions because the technical opinions are really the amalgamations of intelligent minds that are working on investing in the energy space.

EQ: In this week’s Sector Watch report, you looked at the energy sectors within several of the S&P’s major indices to see if investors may want to cut and run, or see this as an opportunity. First, which energy groups have been hit the hardest during this slide?

Stovall: Actually, the S&P SmallCap 600 energy group was hit the hardest. During the holiday-shortened trading week that surrounded Thanksgiving, the S&P SmallCap 600 energy sector had the worst performance, declining close to 19% as compared to the S&P 500 energy group’s decline of about 9%. In the prior six months, again, small-cap energy stocks took it on the chin, falling more than 40% as compared with the large-cap energy stocks falling about 16%.

Really, the biggest decline occurs with those companies that probably really don’t have the capital reserve to weather an extended decline in energy prices.

EQ: Does the energy sectors look attractive from here?

Stovall: There has been six times since 1990 that this sector traded as low or lower than it currently is on a trailing 12-month relative strength basis, meaning as compared with the performance of the S&P 500, and 24 months after what we found was that the energy sector was up six of six times and beat the market five of those six times. The margin of outperformance was an average of 16 percentage points.

If you think the S&P 500 energy’s 24-month performance was good, then take a look at the S&P SmallCap 600 energy’s performance. Whenever we had the relative strength that was equal to or less than where we are right now, on a 12-month basis, the index beat its benchmark by 24% and two years after, it outperformed by an average of 81%.

So while there’s no guarantee that what worked in the past will work again in the future, in my opinion, these low relative strength levels make Black Friday bargains pale by comparison.

EQ: If Energy is one sector to look closely at, are there any that investors may want to stay away from?

Stovall: In terms of which areas would I be avoiding, a concern that I have heading into 2015 is when investors will start preparing for the eventual rate-tightening cycle that will be embraced by the Federal Reserve.

S&P Economics thinks that the Fed will begin raising rates by the middle of next year, so such areas like Utilities—which serves as a proxy for the bond market—could be hit very hard. Utilities are up more than 21%, which is almost twice that of the S&P 500 this year. One reason is that their dividend yield is more than 150% that of the S&P 500, yet their PEG rate is 3.6. That’s about 2.5 times higher than that of the S&P 500. So I see Utilities stocks as being grossly overvalued and very susceptible to increases in interest rates.

I also see Telecom stocks, which currently yield 4.8% as being vulnerable even though their valuations are not as steep. They’re trading at a projected five-year PEG of 2.2 versus 1.4 for the market.

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