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Focus List Update and Outlook for Energy Stocks

By Elliott H. Gue on Jul. 13, 2017

The S&P 500 Energy Index gave up 12.6 percent of its value in the opening six months of 2017—its worst first-half performance since its inception in the late 1980s. The S&P 500 Oil & Gas Exploration & Production Index took a 22.6 percent hit, while Philadelphia Oil Service Sector fared even worse, tumbling 28.2 percent.

Two factors magnified this weakness.

First, many institutional investors went overweight energy stocks after OPEC announced its production cuts, buying the consensus story that oil prices would recover to at least $60 per barrel. But as portfolio managers began to realize that this bullish case rested on a weak foundation, institutional investors sold off energy-related stocks as indiscriminately as they had snapped them up a few months earlier.

Second, the growing popularity of passive strategies meant that retail and institutional investors who piled into energy-focused exchange-traded funds (ETF) after OPEC announced its production cut bid up the group with little regard for company-specific fundamentals. Rotation out of these ETFs over the past three months likewise exacerbated the selloff in energy stocks.

ETF-related buying and selling has created a less efficient stock market where high-quality energy stocks suffer the same punishment as marginal fare. These market dynamics, coupled with shorter cycles in the energy sector, should create additional opportunities for investors to accumulate positions in the higher-quality midstream names that are at the core of our strategy.

Although these trends have been painful for energy investors with exposure to the cyclical upstream and oil-field service segments, these trends create a buying opportunity in the back half of the year.

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