Wall St Week Ahead-Recession fears pose challenge to energy shares after stellar year

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NEW YORK, Jan 27 (Reuters) – A potential U.S. recession and tough predictions for a stellar 2022 are weighing on the outlook for energy stocks that will deliver an encore of last year’s stunning run, despite valuations which are considered to be comparatively cheap.

The S&P 500 energy sector is up 4.2% year-to-date, lagging slightly behind the rise for the broader index. The sector had a 59% jump in 2022, an otherwise brutal year for stocks that saw the S&P 500 drop 19.4%.

Energy bulls argue that the sector’s valuations strengthen the case for a third straight year of earnings, which would be the first such feat for the group since 2013. Goldman Sachs, RBC Capital Markets and UBS Global Wealth Management are among the Wall Street firms that recommend energy stocks.

Despite last year’s run, the sector trades at a forward price-to-earnings ratio of 10 times, compared with 17 times for the broad market, and most stocks its offer robust dividend yields. The potential gains for shareholders were highlighted this week when Chevron shares rose nearly 5% after announcing plans to buy $75 billion of its stock.

Some investors worry, however, that energy companies may find it difficult to increase profits after big jumps in 2022, especially if an expected US economic slowdown hits commodity prices.

“The group seems to be holding up well, but there is some trepidation because investors are concerned about a slowdown and what that will do to demand,” said Robert Pavlik, senior portfolio manager. at Dakota Wealth.

He said he is slightly overweight the energy sector, including shares of Chevron and Pioneer Natural Resources.

Economists and analysts in a Reuters poll forecast US crude oil to average $84.84 a barrel in 2023, compared with an average price of $94.33 last year, citing expectations of global economic weakness. US crude prices have recently been around $80 per barrel.

At the same time, many investors boosted their holdings of energy stocks in 2022 after years of avoiding the sector, which has often underperformed the broader market amid concerns such as poor asset allocation. capital from companies and uncertainties about the future of fossil fuels. The sector’s weight in the S&P 500 roughly doubled last year to 5.2%.

However, that dynamic may be slowing, said Aaron Dunn, co-head of the value equity team at Eaton Vance.

“People have come back to power in a big way,” he said. “We had that tailwind the last few years, which was that everyone was underinvested in energy. I don’t think that’s the case anymore.”

And while energy companies are expected to deliver strong quarterly reports over the coming weeks after a strong 2022, those numbers may have set a high for this year.

With 30% of the sector’s 23 companies reporting so far, fourth quarter energy earnings are expected to have risen 60% from a year earlier, and 155% for the full year 2022, according to Refintiv IBES. But earnings are expected to fall 15% this year, the biggest drop among the 11 S&P 500 sectors.

Exxon Mobil and ConocoPhillips are among the reports due next week, when investors will also focus on the Federal Reserve’s latest policy meeting.

“Last year was an important year,” said Matthew Miskin, co-chief investment strategist at John Hancock Investment Management. “Now they have to try to overcome that to show growth, and I think it’s going to be a challenge.”

Meanwhile, bullish investors point to shareholder-friendly cash use by companies.

The energy sector’s 3.43% dividend yield through year-end 2022 was nearly double the level of the index overall, according to Howard Silverblatt, senior index analyst at S&P Dow Jones Indices. Energy companies carried out $22 billion in share buybacks in the third quarter, just over 10% of the S&P 500’s buybacks.

“From a total return perspective, that’s where I think energy can still continue to differentiate itself against the broader market,” said Noah Barrett, leader of energy and utilities sector research at Janus Henderson Investors.

Others, however, believe that more value may exist in areas of the market that were battered last year. Dunn, of Eaton Vance, said that stocks in areas such as consumer discretionary and industrial may look more attractive.

“Energy will probably do well this year, but I think you have a lot of areas in the market that have gone extremely poorly where we’re finding an excellent opportunity,” he said.

(Reporting by Lewis Krauskopf; Editing by Ira Iosebashvili)

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