Morgan Stanley’s equity strategists think the bull market in stocks is riding into the sunset.
They still expect stocks to rise before this cycle is over, but they say performance will be led by fewer stocks and accompanied by higher risk.
As investors turn more defensive, energy will be a sector that benefits, the strategists say. They’re betting that more efficient spending from US producers and further supply controls from OPEC should benefit energy stocks.
“We remain bullish on energy as a classic late cycle sector with oil price support and defensive characteristics that should buoy the sector as market leadership shifts more defensive later this year,” Michael Wilson, the chief equity strategist, said in a note on Monday.
A part of this bullish call on energy hinges on the expectation that history will repeat itself. If this economic cycle is truly approaching its end, then energy stocks could once again play catch-up as demand for oil rises faster than supply.
A more immediate catalyst for energy stocks is rising oil prices.
On Monday, US oil prices topped $70 a barrel for the first time since late 2014. Brent crude oil, the international benchmark, topped $76 a barrel, higher than Morgan Stanley’s oil strategists had expected prices to be by the third quarter.
The rebound in oil prices has helped the energy sector deliver the most S&P 500 earnings growth over the past year and substantial growth since 2015.
“Not only have earnings been moving higher for energy, but the uncertainty around those earnings seems to have peaked as well,” Wilson said. That’s because analysts’ earnings estimates are increasingly in line with each other.
“Declining analyst dispersion of estimates implies greater confidence on earnings achievability which should mean forecast earnings are rewarded with a higher multiple,” Wilson added.
Wilson further noted that energy’s price-to-book ratio was lower than its historical average.
“We think the extreme levels of relative valuation are pricing in overly bearish expectations on trends that will take longer than the market expects to play out,” he said.
Finally, unlike tech and other recent outperformers in the market, energy is not a crowded trade.
“An under-owned energy sector with a small overall market cap weight could benefit from market rotations and flows in an outsized way as our late cycle thesis plays out,” Wilson said.
The firm’s top picks in energy include Continental Resources, Encana Corp, and Marathon Petroleum.
Leave a Reply
Leave a Reply
This site uses Akismet to reduce spam. Learn how your comment data is processed.
