More than 25 percent of companies in the S&P 500 and the S&P 500 Energy Index have reported fourth quarter earnings so far.
Quarterly earnings season is a busy time for investors. Stocks tend to see some of their biggest moves of the year as these reports are released. But late January and early February, the heart of the fourth quarter season, are some of the busiest times of all. That’s because most firms use their fourth quarter earnings release as a time to offer guidance or, at the very least, broad expectations for the year ahead.
So far 80 percent of the energy firms in the S&P 500 have beaten consensus expectations. Although that does sound impressive, it’s important to keep in mind that these expectations have fallen precipitously in recent weeks--reporting firms are more or less stepping over a lowered bar of expectations.
So far I’ve listened to or read transcripts for 10 large energy firms reporting earnings. Without exception, these calls can be characterized as downbeat. Even normally optimistic CEOs such as Weatherford International’s (NYSE: WFT) Bernard Duroc-Danner emphasized the lack of visibility and the weakness in the energy market globally. In most cases analysts have used the weak tenor of these calls as an excuse to slash earnings estimates for 2009 yet further.
Adding to the general gloom is the fact that crude oil and natural gas prices have remained depressed. Natural gas has fallen despite a continued normalization of inventories.
Nonetheless, what’s truly encouraging is the reaction to this downbeat news and commodity price environment. Of the 10 companies in the S&P 500 Energy Index to have reported earnings since Jan. 1, not one is actually trading lower since its announcement. The average gain since the release of fourth quarter reports: more than 9 percent. That’s impressive.
Investors often don’t analyze earnings releases and other bits of news correctly. Remember, companies have a tendency to be most bullish near the top of the cycle, when their stocks are trading near all-time highs, and most bearish when the stocks are scraping multiyear lows. A stock’s reaction to a negative earnings release and weak guidance is at least as important as the numbers themselves because it gives us a real window into investors’ collective expectations.
In this case, the feeling I’m getting from this earnings season is that investors were already expecting bad news and a weak outlook for the year ahead. They didn’t wait to hear this news to sell the stocks; the stocks have largely already fallen to price in the weak releases and weakening commodity environment.
We’re beginning to see this reflected in the charts for energy-related indexes.
The chart above shows two panes. The top pane plots the path of both the S&P 500 and the S&P 500 Energy Index over the past year; I normalized both indexes to illustrate the relative trends.
The bottom pane is simply the ratio of the S&P 500 Energy Index to the S&P 500; when this line rises, energy is outperforming the broader market.
As you can see, the S&P 500 Energy Index handily outperformed the broader market until early July. The index actually reached its high in late May, up more than 25 percent at that point in the year. Note that the index itself topped out more than a month before oil and gas prices hit their highs--the stocks led the commodities.
After mid-summer, both the S&P 500 Energy Index and the S&P 500 fell sharply; however, the energy sector fell faster than the broader market through early October. In other words, energy stocks totally reversed their outperformance in the first half of the year in just three months.
Here’s where it gets interesting. Since early October, oil and natural gas prices have continued to fall, and the news out of energy stocks has hardly been positive, yet energy stocks once again began to outperform the S&P 500. This trend has simply accelerated since the beginning of 2009 as energy stocks have begun to release earnings.
My take on this is simple: Energy stocks are washed out. Investors are already more than aware of how bad the environment is for commodity prices and what effect it’s having on earnings for the sector. All those funds and institutional traders who were riding the growth wave in the first half of 2008 have long since bailed out and left the industry for dead.
Now, with such negative expectations already baked into the cake, buyers are looking at depressed valuations in the sector as an opportunity to get into top-notch stocks at bargain prices. As I outlined in the most recent TEL, I expect oil prices to remain range-bound in the near term due to a push and pull of falling demand (bearish for oil) and declining production (bullish for oil).
But by year’s end, as the outlook for the economy begins to improve, demand will begin to return to the market and oil prices will head higher once again. It appears that investors are already beginning to anticipate this scenario and are looking beyond weak near-term fundamentals.
Ignore the headlines about falling oil prices and weak earnings because that’s already old news. Now is a great time to be investing in the energy patch.
To maximize returns selectivity is absolutely key. In next week’s issue of The Energy Strategist, I’ll be taking a closer look at recent earnings releases from major energy firms and comments made by management teams during the all-important quarterly conference calls. I’ll be looking at which stocks are most vulnerable and which stand the best chance of outperforming in coming months.
A few key trends bear watching. First, as I highlighted in the most recent issue of TES, interest in nuclear power is building the world over. Companies involved in building nuclear plants, mining uranium and other related industries are seeing the benefit. These stocks have been quietly rallying for months now, despite still-jittery broader market performance.
Second, the master limited partnerships (MLP) are starting to surge. After the worst year on record for the Alerian MLP Index, the publicly traded partnerships (PTP) have handily outperformed the S&P 500 so far in January; the Alerian MLP Index has rallied 15.9 percent, compared to a decline of 3.3 percent for the S&P.
I suspect this is largely due to normalization in global credit markets. I wrote about this thawing in the January 16, 2009 Pay Me Weekly, Early Signs of a Credit Thaw. Several major companies have managed to access the credit markets in recent weeks, selling bonds or taking on new lines of credit from banks. Some of these firms--notably Nabors Industries (NYSE: NBR) and Weatherford International--are in the energy industry. While capital is more expensive, it’s becoming available once again.
I’m also encouraged by Pfizer’s (NYSE: PFE) recent decision to buy rival drugmaker Wyeth (NYSE: WYE) in a $68 billion deal. Pfizer is financing roughly a third of this deal with a $22.5 billion syndicated loan arranged by a consortium of five major banks. This is the largest syndicated loan deal in nearly a year and illustrates that this market is once again coming to life.
I posted commentary about the deal to At These Levels yesterday; obviously Pfizer isn’t in the energy business, but it’s encouraging to see deals getting done again.
In closing today’s issue, I’d like to extend a special invitation to all Energy Letter subscribers to attend the Atlanta Wealth Conference, hosted in a beautiful mountain setting in northern Georgia. This conference has always been a personal favorite of mine, as it’s smaller than most with only 175 attendees.
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