From Standard & Poor's Equity ResearchAt first glance, the S&P 500 Energy sector index's 10.4% gain year-to-date through July 21 is impressive. But the index has actually hit a rough patch in recent weeks, falling 2.1% in July and more than 5% in the week ended July 21. These performances may be due, in our opinion, to investors' expectation of a worldwide economic slowdown, as well as the U.S.'s attempts to end the fighting in the Middle East. Investors may also be convinced that this sector can't maintain a leadership role forever, particularly since earnings growth will likely erode to zero by the final quarter of this year.
But the overriding question remains: Has the love affair with energy stocks soured for the longer term, or is this weakness something that will play itself out in the near term?
The relative strength chart for the Oil & Gas exploration and production subindustry shown below demonstrates a rolling over of momentum. In addition, this "rounded top" formation is also seen in the chart for the Oil & Gas Drilling index (not shown).
NATURAL GAS DRAW. As a reminder, the jagged blue line represents the subindustry index's rolling 52-week price performance as compared with the 52-week performance for the S&P 1500. Any point above 100 indicates market outperformance over the prior year, while points below 100 indicate market underperformance. The red line is a rolling 39-week moving average, while the two green bands indicate one standard deviation above and below the subindustry index's 14-year mean relative strength.
Even though the momentum appears to be waning for this group, in our view S&P's equity analysts continue to have positive long-term investment outlooks for most of the energy subindustry indexes. Our view reflects a tight market characterized by scant spare capacity still vulnerable to disruptions from significant supply sources (e.g., Middle East, Russia. and Nigeria).
However, while we also believe that these markets have created slightly more idle capacity by virtue of lower worldwide demand expectations and historically high seasonal natural-gas storage levels, we believe current natural-gas prices are below their long-term equilibrium price, thus providing an attractive opportunity into onshore North American natural gas producers.
The table below shows the subindustry name, the market-cap weighting that the subindustry index has within the S&P Energy sector—which itself represents a shade more than 12% of the S&P 500—and S&P's investment outlook for each: