Well, that market correction didn’t last long. Some investors are already moving back into “risk on” trades. But before you dive back into big tech, it’s worth taking a look at other corners of the market.
Namely, energy stocks. In an era of comparatively lower oil prices and regular underperformance for the big names in the space, many traders have written off the oil and gas sector. There doesn’t seem to be a lot of growth here, and other investments have better stories to tell than drilling for fossil fuels.
But energy has quietly been getting its footing over the last year or so. And despite some recent setbacks in January and February, it may be time to consider an investment in the energy sector once more.
Read: Investors, put energy stocks at the top of your watch list
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For starters, the biggest reason to look at energy stocks is the steady gains in oil prices since their summer lows. Crude oil CLH8, +0.34% has moved up from roughly $45 a barrel to comfortably above $60, even taking into account the recent drop after volatility rocked the markets in the last few weeks.
Oil hasn’t topped the $60 mark since mid-2015. And before its recent trouble, oil had a serious shot at hitting the $70 mark — a place crude hasn’t visited in more than three years.
There’s reason to think these levels will stick, too, given recent talk of inflation concerns after the January CPI data. A steady weakening of the U.S. dollar DXY, +0.54% over the last 12 months, despite all the talk of tighter monetary policy at the Federal Reserve, also has created a tailwind for oil; as a dollar-denominated commodity, a weaker greenback means stronger oil prices.
Hopes of higher energy prices alone is encouraging for the oil patch. But at the same time, we are seeing signs of increased optimism — and drilling — among U.S. oil companies. Consider the most recent rig count from Baker Hughes BHGE, +1.49% that showed a 31% increase compared with the same week last year. With higher prices, that activity is bound to pay off.
Plus, the oil and gas industry is hiring again, with a report by NES Global Talent noting at the end of 2017 that companies were adding more people than they were letting go for the first time in three years.
All this as energy companies have come to grips with the “new normal” of lower energy prices compared with the oil prices north of $100 as recently as 2014. Gains in efficiencies and operations are sure to stick and, much like the housing industry after the mortgage meltdown, Big Oil is in no hurry to undo those changes and return to the old ways of doing things.
It’s also worth mentioning that some of the best performing bonds over the last year or so have been energy-related junk. Investors are diving into the asset class with abandon, forgetting the dire headlines from a few years ago such as “Warning: Half of oil junk bonds could default.” For better or for worse, the energy sector has easy access to capital right now — capital that can be deployed for production, dividends, acquisitions, and everything in-between.
It all adds up to a pretty compelling case for energy stocks. But what’s the trade?
To start with, you can always jump into an energy ETF to play the biggest names in the sector. But be aware that the biggest funds in the space are not exactly big on diversification. Both the Energy Select Sector SPDR Fund XLE, -0.25% and the Vanguard Energy ETF VDE, -0.24% , which hold about $22 billion under management between them, are weighted towards large-cap stocks. (Two companies, Exxon Mobil XOM, +0.43% and Chevron CHV, +1.01% reflect more than one-third of these ETFs’ portfolio allocation.)
That could be dangerous. Exxon’s scale is unrivaled, but an ugly fourth-quarter earnings report resulted in a steep 13% pullback over several trading days. That should definitely set off warning bells. And before you go bargain-hunting, keep in mind that even after the plunge, the energy giant sports a forward price-to-earnings ratio of about 16.
Chevron similarly saw trouble after its earnings report, even though tax benefits delivered bigger profits. Shares are also off by double-digits — and the stock also is no bargain, with a price-to-earnings ratio above 17.
My favorite pick is an oil giant that isn’t in the top 10 holdings of either of these mainstream energy ETFs — Anadarko Petroleum APC, -0.74% .
That may sound odd. After all, the company slashed its dividend 82% in 2016 after troubles adapting to lower oil prices. And while Chevron and other select oil stocks got some swagger back in 2017 Anadarko suffered a more than 20% decline to log one of the worst performances in the sector.
But Anadarko has raised capital and focused its operations by divesting gas-oriented assets over the last two years, and it has cut jobs and spending to become a much leaner operation. As a result, margins have marched significantly higher.
In fact, during the latest earnings call, officials said Anadarko is looking for “additional efficiencies and improving margins even if oil prices remain static” and that “each dollar (in oil prices) above $50 produces an incremental $100 million of cash flow.” In other words, oil at $60 — where it is now — generates an additional $1 billion in cash flow to power more drilling, as well as a return of capital via dividends and buybacks.
That’s already materializing, with the company pushing its dividend up from 5 cents to 25 cents a share this month after a strong earnings report, on the back of a $2.5 billion buyback program announced in September.
Anadarko is hardly out of the woods, so more conservative investors may find more stability in an energy ETF or in a megacap like Exxon. However, if you truly think the energy sector is back on track, then now may be a great time to jump into Anadarko stock before it goes ex-dividend on March 14.