Sector Earnings Estimate Revisions Update: Divergence in Commodities
Tracking analyst earnings estimate revisions activity (i.e., are estimates rising or falling, and by how much?) is a key feature of our research. With earnings season underway, we can check in on how revisions activity looks across the 11 US sectors, where we find, among other things, a big divergence between the commodity-related sectors of Energy and Materials.
Commodity prices diverging: energy vs the rest
Last month we commented that while the CPI readings remain very high, there are signs of moderation in commodity prices. With commodity prices remaining center stage as a macro driver, we continue to closely watch the various commodity indices, including the S&P GSCI index and its subcomponents.
There now seems to be a greater divergence between energy prices and other commodities.
The chart below shows the S&P GSCI Commodity Index (top section) along with its component indices over the last three years.
A closer look at gasoline and oil prices
Gasoline prices remain in the headlines, and leave an impression every time a driver fills their tank as prices hit new highs.
Oil prices are a global issue, with OPEC and the US being the biggest producing regions. Producers face mixed incentives about increasing production longer-term, including messages from the futures markets.
Gasoline and diesel refiners face reduced capacity, leaving them struggling to meet even historically normal levels of demand despite high potential profit margins.
Energy sector supported by recovering output and elevated prices
We remain overweight the Energy sector, as analysts continue to raise earnings estimates and the sector is very favorably valued, though the picture has become somewhat more mixed as crude oil prices have been volatile recently. News of the new Omicron variant of COVID-19 and corresponding constraints on international travel have renewed concerns about fuel demand, while OPEC’s decision to go ahead with output increases has reduced the earlier concerns about insufficient supply.
Big moves in energy markets
Volatility in the crude oil and natural gas markets has been a big topic among investors and policy makers recently. Limited supplies and higher demand are pushing prices higher, and stock prices in the Energy sector are responding.
The chart below helps put recent movements in perspective, seen in the context of the last five years. Crude oil prices (second section, in red) have just recently topped their 2018 peak, completing a full recovery from the COVID-related drop and weakness that preceded COVID. But the five-year average for crude oil has been about $55/bbl, with a low of $25 (on this measure, which uses an average of the next 12 months of crude oil futures contracts to avoid near-contract distortions) and a current high of $76. So crude is elevated but not at an extraordinary level given it was at about the same price in October 2018. And it reached much higher levels above $100/bbl. back in 2008, 2011, and 2012.
Energy sector has rallied, but optimism is already high on crude oil
The recent returns of the Energy sector have been dramatic: in just two weeks from its latest trough on November 6th (just before the Pfizer vaccine news hit), the S&P 500 Energy sector rose 37%, the biggest return of any of the major sectors by a wide margin. The overall S&P 500 index, meanwhile, returned only 3.6% in that period. Most recently, the gains in Energy have cooled somewhat, but the sector (as of Dec. 2nd) is still up 30% from its November 6th level, well ahead of all other S&P 500 sector returns over the period.
Big divergences in commodity space still favor Materials over Energy
One of the themes in our sector research for clients recently has been to focus on relative preferences within broader style or macro categories, rather than making big macro bets on Growth versus Value or Cyclical versus Defensive areas. We find that in a more range-bound market with conflicting macro trends, a more granular view is often more effective.
One stance we have held for some time has been within the Value-oriented commodity space. While in many cases historically the Energy and Materials sectors have moved together, this year has seen a dramatic divergence between the two commodity-related sectors. We have favored Materials over Energy this year, and still do, and below are some of the drivers of that view.