In November 2021, a BofA Securities strategist provided eight reasons for ranking U.S. energy stocks the No. 1 most attractive sector in the S&P 500. The potential for geopolitical conflict, which sadly later occurred in the Ukraine, was only one driver of the expected price rally in oil.
In an update this week, the strategist, Savita Subramanian, noted that while the Russia/Ukraine conflict is likely already priced into crude, the other seven reasons for bullishness are still in play. For her, this strongly suggests oil prices will remain elevated for the foreseeable future.
In brief, the seven remaining reasons are: energy stocks offer inflation-protected yield; the sector is close to record low valuations relative to strong cash flow generation; actively managed funds are still 30 per cent underweight; capital discipline has been maintained; decarbonization plans are reducing ESG-related investor opposition; sector earnings are predicted to exceed consumer discretionary stocks; and funds that are underweight are significantly underperforming the benchmark.
The S&P 500 Energy Index’s year to date return of 29.6 per cent has outperformed the S&P 500 by almost 40 percentage points. Domestically, the S&P/TSX Energy index has climbed 22.1 per cent, easily outdistancing the primary benchmark’s 1.5 per cent appreciation.
The majority of fund managers that remain underweight in oil and gas stocks, for ESG reasons or any other, are experiencing career risk - underperforming their benchmarks by a wide enough margin that their jobs are increasingly threatened. The temptation to capitulate and allocate assets to the sector will be very strong in many cases and this would push related stock prices even higher.
Somewhat surprisingly, U.S. energy stocks remain attractively valued after the strong rally (comparable data is not available for Canadian companies, although many also trade in the U.S.). Based on historical averages, Ms. Subramanian estimates 62 per cent potential upside based on current price to operating cash flow multiples. A jump in energy stock prices to average price to book value ratios implies 48 per cent upside.
The most profitable investment time horizon for investment in oil and gas is difficult to gauge. Over time, renewable power will cut deeply into fossil fuel demand but it will be a number of years before these effects become financially tangible. An increase in nuclear power is almost guaranteed but facilities cannot be built overnight, and the related politics remain contentious and likely to cause construction delays at the very least.
There are many ways in which energy stocks have been pushed into the sin stock category because of environmental concerns, joining alcohol and tobacco. But here’s a fact investors may want to consider: tobacco stocks were the top performing market sector between 1900 and 2020, turning a US$1 investment into more than US$8-million.
-- Scott Barlow, Globe and Mail market strategist
This is the Globe Investor newsletter, published three times each week. If someone has forwarded this e-mail newsletter to you or you’re reading this on the web, you can sign up for the newsletter and others on our newsletter signup page.
SPACs splash the cash to salvage deals as market unravels
SPACs are turning to costly new tactics to keep investors from jumping ship as market confidence wanes in the once red-hot alternative to IPOs. Blank-check acquisition firms and the companies they acquire are having to hand over bigger stakes in the ventures to investors in some cases, often at big discounts. Deal managers are also seeking backstop financing from investment firms and plowing in more of their own cash. Less than three months into 2022, 13 mergers involving special purpose acquisition companies have already fallen through in the United States.
History shows U.S. stocks can weather rate hike cycle
Fears over the Federal Reserve’s hawkish shift have combined with geopolitical uncertainty to push the S&P 500 into a correction this year, yet historical data suggests tighter monetary policy has often been accompanied by solid gains in stocks.
Investors see risks spiking, fear market-wide liquidity crunch
Wild swings in asset prices after Russia’s invasion of Ukraine are prompting some investors to pare risk in their portfolios, fearing that the type of volatility seen in commodities in recent weeks could hit other markets. At issue is liquidity – or the ease at which investors can buy or sell an asset without affecting its price. While episodes of low liquidity have contributed to sharp gyrations across markets over the past decade, signs of stress have become more plentiful in the past few weeks, exacerbated by everything from sanctions against Russia to expected central bank tightening.
Also see: Survey finds investors dumping stocks, fleeing to cash as growth outlook hits weakest since 2008
Bitcoin’s scared of commitment, Mr. Biden
Bitcoin loves flirting with the mainstream. But now, as the U.S. President says he wants to get serious, it may be getting cold crypto feet. When Joe Biden ordered officials to prepare reports on the role of cryptocurrencies in future finance last Wednesday, bitcoin leapt as much as 9 per cent and ether 8 per cent, as many crypto fans hailed a potential milestone in mainstream acceptance. Yet cryptocurrencies are complicated. The rally didn’t last long. Here are some reasons why.
How Wall Street star Cathie Wood is defying her doubters
Do you believe in Cathie Wood? Wall Street’s star stock picker has seen her fortunes wane over the past year as her flagship tech innovation fund slid more than 50%, losing US$13 billion in market value. Yet investors have continued to buy into her futuristic vision, according to data from industry tracker Lipper: not only holding tight but plowing more than $2 billion in additional net inflows into the fund at her firm ARK. While much has been written about the decline of her ARK Innovation exchange-traded fund, this story is the first to draw on a range of interviews, with about a dozen ARK employees, investors, and others within Wood’s world, to show how she is trying to keep her reputation intact as she navigates the flip side of fame.
Others (for subscribers)
Foreign-listed Chinese stocks rally as Beijing soothes nerves
LME nickel trading halted in chaotic market resumption
No ‘stag’, some ‘flation’: bets on Europe Inc are still on
Number Cruncher: 10 Canadian dividend payers with low geopolitical risk
Number Cruncher: 15 U.S.-listed companies with great revenue and superior earnings growth
Wednesday’s analyst upgrades and downgrades
Tuesday’s analyst upgrades and downgrades
Wednesday’s Insider Report: Chairman invests $5-million in this dividend stock over the past six weeks
Tuesday’s Insider Report: CEO and Chairman accumulate this oversold dividend stock
Why the ‘culture of now’ is making it difficult for Canadians to save for retirement
Are you a financial advisor? Register for Globe Advisor (www.globeadvisor.com) for free daily and weekly newsletters, in-depth industry coverage and analysis, and access to ProStation - a powerful tool to help you manage your clients’’ portfolios.
Ask Globe Investor
Question: Recently my discount broker issued a T5008 Statement of Securities Transactions showing the disposition of 311 shares of Brookfield Infrastructure Partners Exchange LP in August, 2021. The cost or book value was stated as $8,560.56 and the proceeds of disposition were $22,158.75, which means I am facing a large capital gain. However, I’m puzzled because I did not sell any shares; in August I simply exchanged the shares – which I had acquired when Brookfield Infrastructure Partners LP (BIP.UN) bought Enercare Inc. – on a one-for-one basis for shares of BIP.UN. So I fail to understand why there are any tax implications. I had a long phone call with two different people at my broker that did not clear this up. Can you shed any light?
Answer: When Brookfield Infrastructure acquired Enercare in 2018, Enercare shareholders had the option to defer capital gains tax by accepting, in lieu of cash, “Exchangeable LP Units” that are convertible into units of Brookfield Infrastructure Partners LP. Evidently, you elected this tax-free rollover option.
However, the exchangeable units were not intended to remain tax-free forever. On page 72 of the management information circular for the transaction (available on sedar.com), Enercare stated: “The disposition … of an Exchangeable LP Unit, including on a redemption or exchange of Exchangeable LP units for BIP units … will result in the realization of a capital gain (or capital loss)” by the unitholder.
So, when you swapped your exchangeable units for BIP.UN units last summer, it triggered a taxable event. If it’s any consolation, remember that only 50 per cent of capital gains are included in your income for tax purposes.
What’s up in the days ahead
Why are cybersecurity stocks not getting a big boost from the Russian invasion of Ukraine? Tim Shufelt will have some answers.
Click here to see the Globe Investor earnings and economic news calendar.
More Globe Investor coverage
For more Globe Investor stories, follow us on Twitter @globeinvestor
You may also be interested in our Market Update or Carrick on Money newsletters. Explore them on our newsletter signup page.
Compiled by Globe Investor Staff