Energy was the strongest sector yesterday. XLE is now trading at its highest level since mid-2008, when oil was still above $100 / barrel. The cause for today’s run in XLE is less about oil, which is the same price it was a year ago, and more about investors’ willingness to pay higher valuations for stocks.
The 4 year weekly chart shows the breakout of XLE:
The largest components in the energy space are XOM, CVX, SLB, OXY, and COP. XOM and CVX are the $400 and $250 billion market cap behemoths, and the other 3 are between $75 and $105 billion in market cap size. With the exception of SLB, which is a faster-growing oil services name, the other 4 oil majors are basically value stocks with earnings growth prospects between 0-5% per year, priced at 10-15x P/E multiples.
The recent rally in the space is part of the rotation theme, as investors decide to dump utilities and staples names trading at 15-20x, and take a bit more risk with the energy sector since it’s trading at 10-15x. Of course, they’ve stayed away from energy until now because of the greater risk to energy earnings, especially since crude oil has declined 10-20% in a month in risk-off scenarios over the past few years. Nonetheless, investors are more willing to wade into the riskier pond when the “safe” ponds are no longer priced for safety.
I was wrong about the energy sector in the past month. Part of it was that oil has held up better than I expected given the broader commodity weakness. But part of it is about how a different macro backdrop can change investors’ willingness to buy certain stocks, even if the stocks’ own business outlook might be worse off.
In that sense, even though most of the major energy stocks are likely to earn substantially less in 2013 than they did in 2011, investors are willing to pay more for them because energy shares look cheaper on versus other sectors a relative basis than they did in 2011. The broader investment landscape holds more importance for the appeal of shares than simply the valuation of a stock relative to its own historical valuation. That’s why the macro and the micro matter together, even if your time frame is measured in years.