SP 500 Weekly Earnings Update: Continuing to Overweight Energy

Thomson Reuters I/B/E/S Data by the numbers:

Forward 4-quarter estimate: $131.39 versus $131.50 last week

P.E ratio: 18(x)

PEG ratio: 2.3(x)

SP 500 Earnings Yield: 5.59% vs 5.68% from prior week

Year-over-year Growth of Forward estimate: 7.93% vs last week’s 7.88%

YTD SP 500 sector returns: (per Bespoke as of 2/17/17):

  • Tech: +8.86%
  • Health Care: +6.51%
  • Cons Disc: +6.16%
  • Cons Spls: +5.02%
  • Industrials: +4.93%
  • Financials: +4.90%
  • SP 500: +4.79%
  • Ute’s: +1.41%
  • Telco: -4.59%
  • Energy: -5.80%

Analysis/conclusion: In an overbought market (seemingly) where everyone is looking for a pullback, the Energy sector is the most oversold of the 11 SP 500 sectors, and for good reason. Energy’s market cap weighting in the SP 500 is roughly 8%, and clients hold a roughly 8% – 10% Energy weight in their respective accounts (depending on the client), and that weight might be lifted a 1% or 2% this coming week given the sector’s oversold status.

The top three sectors in the SP 500 (by market cap weighting) are Technology at 20%, Health Care at 15% and Financial’s at 15%. Relative to the benchmark weighting, Technology remains client’s largest overweight relative to the SP 500 weight, Financials are overweight to neutral weight depending on the client, and Health Care is currently the most underweight at just 3% – 5% of accounts, but that weighting is currently being boosted after Health Care’s under-performance in 2016.

The dividend or “safety trade” we stayed away from for years which means Utilties, Telco, Reit’s, MLP’s, were never owned in any real size or quantity (or at all for that matter) and this “trade” continues to under-perform relatively as interest rates start to rise, and a “return to global growth” theme starts to unfold across much of the world’s markets.

How do “expected” Energy earnings look today (Source: Thomson Reuters I/B/E/S, “This Week in Earnings” as of 2/17/17)

  • Q4 ’17:  +162.7% vs 136.7% as of Jan 1 ’17.
  • Q3 ’17: +220.9%, vs 227.8% as of Jan 1 ’17.
  • Q2 ’17: +791% vs 730% as of Jan 1 ’17.
  • Q1 ’17: +733.6% vs N/A as of Jan 1 ’17.
  • Q4 ’16: -0.8% vs +4.9% as of Jan 1 ’17

While the percentages look strong, this is a function of the Energy sector’s very bad earnings in 2016. The expected net income dollar amounts or profitability are lower than prior years but there is still Energy sector earnings growth expected in 2017.

Energy’s bear case is well understood, and the frackers that will turn on marginal projects if crude stays in the low $50 price range. I do think the Energy pricing landscape is forever changed with US fracking, and we likely wont see $100 crude oil for – well – ever given some of the recent findings (like in Mexico, etc.), however, the easy compares with last year, the poor sentiment around the sector and the longer-tailed cycles of the sector, lead me to conclude that giving the sector one or two more quarters to work higher makes sense. (Long the XLE, OIH, IYE, and a small position in XOP.)

One final thought on the sector. Factset’s earnings work, is first-rate, and high quality. On Factset’s Weekly Earnings Insight, there is a section which details the “upward” and “downward” change in EPS estimates for the top 10 companies within the SP 500 respectively. It is an interesting graph for momentum investors that wish to follow trends in estimate changes.

The point is, in this week’s Earnings Insight, 5 of the top 10 companies with the greatest “upward change” in Q1 ’17 EPS are Energy companies.

1.) Pioneer (PXD): 715%

2.) Anadarko (APC): 227.5%

3.) Murphy Oil (MUR): +123%

7.) Conoco (COP): +99%

10.) Concho (CXO): +57%

And to be even-handed for readers, of the Top 10 with the “downward-change” in Q1 ’17 estimates, 4 are also Energy companies:

3.) Phillips 66 (PSX): -48%

6.) Marathon Petroleum (MPC): -83.6%

9.) Transocean (RIG): -192.4%

10.) Baker Hughes (BHI): – 356%

No question that today, Energy is what Jim Cramer would call a “battleground” sector. The deep-water drillers like RIG and Diamond (DO) are thought to be in secular decline. There is just going to be less demand for deep-water oil and gas equipment with the emergence of fracking technology.

To conclude, given the sentiment and uncertainty around the sector, I thought it was worth a trade to the long-side for the next quarter or two. Exxon (XOM) and Chevron (CVX) account for the lion’s share of the sector net income and earnings, and together the two international, integrated oil giants comprise roughly 30% or more of the XLE and IYE energy ETF’s. Chevron had a disappointing Q4 ’16 earnings report and call, and CVS is now nearing its 200-day moving average. Exxon is still below its 200-day moving average.

While ETF’s are currently being used to invest in the sector, individual companies may and can be bought and I may not post an update. The Q1 ’17 earnings reports will matter much both in terms of the actual results for the sector and how the stocks react to the financial results.

(Readers are free to take or leave any information on this blog that is helpful to them, (both today’s post or anything written previously), but the position and / or sector weightings may change at any time, and positions may be added or sold and no update posted, or posted only in hindsight. Clients always come first. Personally, writing the blog posts are a way to flush out my thought process and crystallize my own opinions, based on the research done for clients, but the fact is markets change daily and weekly. Adjustments, changes and allocations can change quickly based on market conditions, and readers may only see it in hindsight, if at all.)

Thanks for reading.

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