Despite Earnings Gains, S&P Still Underweights Energy-Sector Stocks

By Toal, Brian A

Remarkably, the S&P 500 is still underweighting energy stocks despite that sector’s earnings gains and contribution to the index. However, that’s likely to change within the next decade, according to one analyst. During the two-decade-long energy bear market from the 1980s through the early years of this decade, the actual weighting of energy stocks as a percentage of the S&P 500′s market cap was in steady decline, falling from a peak of 28.1% in 1980 to a low of 5.3% in 1999. notes Pavel Molchanov. an analyst with Raymond James & Associates in Houston.

And despite the energy bull run since 2002-with both the OSX (Philadelphia oil-Service sector Index) and the S&P E&P Index outperforming the S&P 500 for four of the past five years as oil prices tripled-only a partial weighting rebound has occurred, with energy’s market-cap weighting in the S&P 500 now around 10.6%-still lower than a 30-year average weighting of 11.5%.

Why such a disparity between energy earnings contribution and S&P market weighting? “The biggest reason is that the market does not believe $80-plus oil is sustainable,” Molchanov says. “Also, the market does not seem to believe that natural gas prices, recently at depressed levels, will eventually rebound.

“However, given our thesis that long-term energy fundamentals are very bullish relative to the overall market, we are projecting $80 oil for 2008-up 18% versus 2007-followed by $85 oil in 2009-up another 6%,” says Molchanov.

“On the natural gas side, our forecast of $7 per thousand cubic feet for 2008. although flat versus 2007, is followed by a projected $8.50 for 2009-a 22% yearover-year gain.”

The point: Earnings growth from energy companies should continue to outpace the rest of the market for the foreseeable future.

“Investors have yet to appreciate the enormous shift of wealth that is flowing into the energy sector,” Molchanov contends. “However, while it may take time, we believe the market will eventually pay for the phenomenally strong earnings and cash flows that this sector is generating.

“This means investors should look for a long-term sector rotation into energy stocks during the next five to 10 years.”

-Brian A. Tool

Copyright Hart Energy Publishing, LP Jan 2008

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