SOLR - Energy Is Still A Strong Play In 2023
Summary
- All the positive sales and earnings forecasted are concentrated in the top 15% of all stocks that I monitor. In other words, institutional buying pressure is focused on fewer stocks than normal.
- Energy stocks are big winners in 2022. In addition to high energy prices, the buying pressure caused a resurgence in energy stocks.
- The Fed knows it cannot control food and energy prices, but as more evidence emerges that core inflation is cooling, the FOMC will have to follow market rates and stop raising key interest rates.
I mentioned on Fox Business recently that “we are in a 15% stock market,” by which I essentially mean that all the positive sales and earnings forecasted are concentrated in the top 15% of all stocks that I monitor. As a result, the institutional buying pressure that creates the “Alphas” that I seek is chasing fewer stocks than the normal 40% of all stocks that perform well and exhibit relative strength.
In other words, institutional buying pressure is focused on fewer stocks than normal. This acts like a funnel, or even like a “firehose” that is focusing buying pressure into a narrower stream.
I monitor this buying pressure when calculating the quantitative grades in my online stock grading databases, which are designed to identify institutional buying pressure based on Alpha/Standard Deviation, which is essentially “Returns Independent of Stock Market/Volatility.” Essentially, a high quantitative score essentially means that there is persistent and relentless institutional buying pressure.
This is how I identified energy stocks as big winners in 2022. In addition to high energy prices, I saw the buying pressure causing a resurgence in energy stocks. I expect that buying pressure to persist for the foreseeable future, so I expect energy stocks to continue to dominate our stock selection screening.
I should add that major indices are now boosting their energy weights, so institutional managers are now net buyers of energy, since they traditionally like to “track” the indices. One example is that the NASDAQ 100 in its annual rebalancing is adding six stocks, including Diamondback Energy ( FANG ) and Baker Hughes ( BKR ), while removing seven stocks. It’s incredibly bullish for energy that two of the six stocks being added to the NASDAQ 100 are energy stocks, while not one energy stock is being removed.
In other leading sectors we favor, Super Micro Computer ( SMCI ) is being added to the S&P 400, while Steel Dynamics ( STLD ) is being added to the S&P 500. There is no doubt that when the major indices are being updated, companies with strong sales and earnings are being added.
In the case of the S&P 500, energy stocks have surged to approximately 6% of the index, up from barely 2% a year ago. In the upcoming years, I expect that energy stocks will rise to approximately 30% of the S&P 500 as the institutional blowback against ESG investing spreads. The ESG blowback will spread in 2023 as many university endowments and pension funds must explain to their trustees why they avoided investing in fossil fuel companies for ESG reasons. The folks at S&P Global muddied the definition of what ESG means when they booted Tesla ( TSLA ) from its ESG index back in May and added Exxon Mobil ( XOM )!
Just to demonstrate how powerful these indices are, since S&P Global kicked Tesla out of its flagship ESG index to buy Exxon Mobil back in May, Tesla’s stock has been crushed, despite reaching record sales! Now the NASDAQ 100 is following S&P by adding energy stocks and removing some popular technology stocks. We are now in an energy renaissance, where the world is rediscovering the importance of fossil fuels as the G7 strives to break away from Russian-sourced energy supplies.
The jury is still out on the G7’s $60 price cap on Russian oil. All I can tell you is that my tanker stocks “gapped” up in the more aggressive services, so I suspect crude oil transportation is picking up. The LNG business is also robust, now that a cold front enveloped Europe, with natural gas demand soaring. The easiest way for Russia to get around the G7 $60 price cap is to sell crude oil to China, India, Saudi Arabia, and UAE, who refine the Russian crude and sell it as refined products, like diesel, heating oil, and jet fuel.
The primary reason that I expect crude oil prices to rise in the New Year is due to the fact that the Biden Administration is expected to stop draining a million barrels a day from the Strategic Petroleum Reserve ((SPR)), since it is down to its lowest level since 1980 and the new Republican House is expected to be critical of the SPR releases. Furthermore, with China re-opening, crude oil demand should steadily rise.
Finally, crude oil prices traditionally rally in the spring due to increasing seasonal demand, so I feel crude oil prices could easily rise above $100 per barrel in the upcoming months and eventually hit $120.
I should add that The Wall Street Journal reported last week that 180 million barrels of light sweet crude oil were released from the SPR this year at an average price of $96.25 per barrel. There are about 382 million barrels of crude oil remaining in the SPR, down from 593 million barrels at the start of the year.
The Fed’s Interest Rate Drama Will Continue Into 2023
After the Fed’s 0.5% interest rate increase on December 14 th , the Fed funds rate is now essentially at par with the 2-year Treasury note and well above the 10-year Treasury bond yield, so there is no need for another rate increase . The 10-year Treasury bond yield has declined 80 basis points since late October, while the 2-year Treasury note declined 55 basis points since early November. As I have said many times, the Fed never fights market rates, but the 10-year Treasury bond yield has risen is the past couple of weeks and is now at 3.75%, so perhaps the Fed feels it must raise rates once again if rates keep rising.
Other market rates around the world have been rising, such as German 10-year government bond yields, which are now at 2.39%. However, the real surprise was that the Bank of Japan on Tuesday ended its zero interest rate policy and allowed Japan’s 10-year bond yield to rise to a high of 0.488% before ending the week at 0.383%. The Bank of Japan apparently does not like the weak Japanese yen causing inflation, so it had to raise rates from zero or below over the last 20 years to try to shore up the value of the yen.
During Fed Chairman Jerome Powell’s post-FOMC press conference, he refused to acknowledge that the fight against inflation is improving, even though core inflation, excluding food and energy, is steadily improving. As a result, Chairman Powell appears to be at odds with market rates and the dramatic decline in Treasury yields in the past several weeks. It is clear that Chairman Powell wants to fight inflation on services, but if Treasury yields continue to meander lower, the Fed has to hit the “pause” button at last!
The Fed knows it cannot control food and energy prices, but as more evidence emerges that core inflation is cooling, the FOMC will have to follow market rates and stop raising key interest rates. The Fed’s “dot plot” implied that the FOMC would raise key interest rates again at its next meeting on February 1 st , but there will be a lot more economic news between now and then. Either way, the Fed is very close to its last rate hike , and when Wall Street realizes that the Fed will top raising rates, I expect a big relief rally!
When “Bad Economic News” is Really Good News
We are in an environment where we do not want to see strong economic news, since investors want the Fed to stop increasing key interest rates, so good news is actually bad news, and vice versa.
In that spirit, it’s good news that the Commerce Department on Friday reported that durable goods orders plunged 2.1% in November, which was substantially lower than economists’ consensus expectation of a 0.6% decline. Transportation orders declined 6.3% as Boeing’s ( BA ) new commercial aircraft orders fell after rising the past three months. Excluding transportation, durable goods orders actually increased 0.2%, but excluding defense orders, durable goods orders decreased a whopping 2.6% in November.
Military aid to Ukraine has been distorting the durable goods report, as durable goods shipments have risen for 18 of the past 19 months. Overall, the fact that durable goods orders are dependent on military orders to grow may explain how the federal government has been stimulating economic growth.
The Commerce Department on Friday also reported that personal spending only rose 0.1% in November, compared to an upwardly revised 0.9% in October. So personal spending is “good bad news,” and the drop in retail sales combined with the small increase in consumer spending should help to cool inflation.
Speaking of cooling inflation, the Commerce Department on Friday announced that the Fed’s favorite inflation indicator, the Personal Consumption Expenditure (PCE) index, rose only 0.1% in November and is running at a 5.5% annual pace, down from a 6.1% annual pace in October. The core PCE, excluding food and energy, increased 0.2% in November and is running at a 4.7% annual pace, down from a 5% annual pace in October. Essentially, the Fed’s favorite inflation index is cooling off fast, so there is hope that February 1 st will be the Federal Open Market Committee’s ((FOMC)) last key interest rate hike.
Continuing the "bad news is good news" theme, the Commerce Department announced that housing starts declined 0.5% in November to an annual pace of 1.43 million. In the past 12 months, housing starts have declined 16.4%. Building permits declined 11.2% in November to an annual pace of 1.34 million. In the past 12 months, building permits have declined 22.4%. In contrast, completed homes rose 10.8% from October to November, reaching a 1.49 million annual pace. In the past 12 months, completed homes rose 6%. The housing industry is showing some green shoots based on completed homes, which was likely aided when mortgage rates moderated a bit in the past several weeks as Treasury bond yields declined.
The National Association of Realtors announced on Wednesday that existing home sales declined 7.7% in November to an annual pace of 4.09 million. This was the tenth straight monthly decline and the slowest annual sales pace since May 2020. Median home prices are now $370,700, a figure that has declined for five straight months. In the past 12 months, median home prices have risen 3.5%. Obviously, the Fed has “pricked” the housing bubble, and hopefully the cost of “owner’s equivalent rent” will also soon moderate.
The Conference Board announced that its consumer confidence index surged to 108.3 in December, up sharply from 101.4 in November. Economists were expecting consumer confidence to decline to 101, so this was a massive surprise and the highest reading since April 2022. The present situation component surged to 147.2 in December, up from 138.2 in November. Also very encouraging is the expectations component, which rose to 82.4 in December, up from 76.7 in November. Clearly, the consumer likes to “cheer up” during the holidays, and hopefully that will boost sales this holiday shopping season!
The Labor Department on Thursday reported that unemployment claims rose to 216,000 in the latest week, up from a revised 214,000 in the previous week. Continuing unemployment claims decreased slightly to 1.672 million in the latest week, compared to a revised 1.678 million in the previous week.
The Commerce Department revised its third-quarter GDP estimate up to a 3.2% annual pace, up from its previous estimate of 2.9%. Consumer spending was revised up to a 2.3% annual pace from the 1.7% previous estimate and was the primary reason for the upward revision. The bulk of third-quarter GDP growth (approximately 2.77% of the 3.2%) was attributable to the SPR crude oil release, which caused the trade deficit to shrink. I should add that the Atlanta Fed is estimating 2.7% annual GDP growth for the fourth quarter. If there is such a thing as a “soft economic landing,” we appear to be in the midst of it.
Enjoy the holidays!
Navellier & Associates owns Steel Dynamics Inc. ((STLD)) and Super Micro Computer, Inc. ((SMCI)) in managed accounts a few accounts own Tesla Inc. ((TSLA)) per client request. We do not own Exxon Mobil Corp. ((XOM)), Diamondback Energy ((FANG)), Baker Hughes ((BKR)), or Boeing ((BA)). Louis Navellier and his family own Steel Dynamics Inc. ((STLD)) and Super Micro Computer, Inc. ((SMCI)) via a Navellier managed account. They do not own Exxon Mobil Corp. ((XOM)), Diamondback Energy ((FANG)), Baker Hughes ((BKR)), Boeing ((BA)), or Tesla Inc. ((TSLA)) personally .
All content above represents the opinion of Louis Navellier of Navellier & Associates, Inc.
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Disclosure: *Navellier may hold securities in one or more investment strategies offered to its clients.
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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Energy Is Still A Strong Play In 2023