<

Must-know: Why you should stick with energy stocks

Part 3
Must-know: Why you should stick with energy stocks (Part 3 of 3)

Overview: Why the outperforming energy sector affects investors

So what does this mean for investors? For some time, I have been advocating an overweight to this sector, and I continue to stand by that position. The sector provides an important feature today: a potential hedge against rising geopolitical risk. Should events in Ukraine continue to deteriorate and lead to an escalating series of sanctions and higher oil prices, I believe energy stocks are likely to continue to outperform the broader market. I expect tensions to remain high and the issue to linger, although an outright invasion of Ukraine by Russia remains less likely.

Energy Sector vs Oil Prices 2014-07-15Enlarge Graph

Market Realist − The energy sector is tracked by the iShares Energy Sector ETF (IXC). The sector has rallied strongly over the past few years, in line with an increase in oil prices. The United States Oil Fund ETF (USO) represents oil prices.

The rally was also aided by an overall increase in equity markets. Along with the supply issues and uncertainty from the tensions between Ukraine and Russia, production troubles in Libya, Nigeria, and Venezuela are spurring oil prices.

“Some of the oil surge is macroeconomic related, and attributable to the economic strength of the U.S.… and a decent growth rate internationally,” Kurt Hallead, co-head of Global Energy Research for RBC Capital Markets, said in an interview. Rising geopolitical risks seem to point to the energy sector as the best possible hedge.

Beyond the potential for increased turmoil in Ukraine, there are a number of other reasons many investors may want to consider sticking with an overweight to energy stocks. Most importantly, the energy sector is arguably one of the few bargains left in the stock market. The U.S. energy sector trades at 1.9x book value, a significant discount to the broader market and the sector’s own history. On a global basis, the sector is even cheaper, with an average price-to-book ratio of around 1.5.

Beyond value, we believe cyclical stocks like energy should benefit the most from an improving global economy. In addition, the global sector provides a healthy dividend of around 3% as measured by the iShares Global Energy fund (IXC) based off of the S&P Global Energy Index

Finally, while I don’t expect any inflation this year or probably next, should prices ever start to accelerate, energy stocks have historically provided a good hedge against inflation and a loss in purchasing power.

Market Realist − Energy remains an investor-friendly sector. Geopolitical risk is only increasing oil and gas prices.

Read more about why the Iraq crisis is fueling geopolitical risk and raising oil prices in Conflict in Iraq: What rising oil prices mean for the economy & investors.

Funds that concentrate investments in a single sector will be more susceptible to factors affecting that sector and more volatile than funds that invest in many different sectors.

The Realist Discussions