Energy stock bulls pause as recession looms

After two straight years of record highs, investors who profited from booming oil stocks are now betting on a temporary retreat as recession threatens economies in the U.S. and Europe.

A gauge of global energy stocks is set to rise more than 35% for the second straight year, a surge that has pushed Exxon shares to record highs and caused most other oil majors to double from 2020 or triple.

But that rally now looks overdone, given the bleak macro outlook and falling oil prices that have lost almost all of their gains for the year. That’s leading some strategists and portfolio managers to brace for a pullback that could last for months until the damage from a possible recession becomes more apparent.

JPMorgan global market strategist and long-term energy bull Marko Kolanovic is among those calling for an end to the rally, advising investors to turn back only after the broader market falls by 20%-30%.

“We view the sale of energy stocks as a tactical trade. The catalyst for convergence will be a broad equity correction,” Kolanovic wrote in a note to clients, though he said the long-term appeal of oil stocks was intact .

Like most cyclical stocks, energy will struggle in a severe downturn. During past economic contractions, energy has been the worst-performing sector across regions, with EPS falling between 53% and 124%, Citi estimates.

take profit

Generali Investments, which manages 515 billion euros ($543 billion) in assets, has shifted to a “strategic neutral” position on energy, adding to its holdings throughout the year.

“While we still think the sector is structurally undervalued, we now pause for a moment as we deleverage its debt position and grow cash flows at a decent pace over the next few years,” strategist Michele Morganti said.

Investors pulled money from its exchange-traded fund that tracks the S&P Global 1200 energy index, according to BlackRock iShares. The $2 billion fund’s outstanding shares have fallen 15% from a peak in March to levels seen before Russia’s invasion of Ukraine stoked the prospect of supply shortages in the West.

Andrea Scauri, a fund manager at asset manager Lemanik and a former oil analyst, expects big energy stocks to retreat, saying recession risks in Europe and a windfall tax could slow the momentum for a few quarters.

“I don’t have any European oil majors in my portfolio anymore because I take profits when they do well,” he said.

Some are also considering shorting oil stocks to profit from expected price falls. For example, an equity salesman at Mediobanca Securities recommended a bearish bet on Italy’s major Eni.

The run pushed the market capitalization of six major U.S. and European oil companies – ExxonMobil, Chevron, Shell, TotalEnergies, ConocoPhillips and BP – to nearly $1.4 trillion, the highest since 2008 .

structural tailwind

Like JPMorgan and Generali Investments, Lemanik’s Scauri remains optimistic about the long-term outlook after years of underinvestment in exploration and current geopolitical tensions complicating supply routes.

He still likes to get involved in the industry, but through companies that don’t face windfall tax risks like pipe maker Tenaris, shippers like D’Amico or service providers like Subsea 7 and Technip.

Others stuck to their bullish views. Roland Kaloyan, head of European equity strategy at Societe Generale, is overweight energy stocks going into 2023 and sees a potential for new sector highs between the second and third quarters of next year.

The MSCI World Energy Index has risen 72% relative to world stocks over the past two years, but is down 12% from a four-year high last month. Generali’s Morganti said European energy may have already halved.

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