The energy sector has been showing promising signs of recovery after a challenging year, and this is especially true for oil and gas stocks. With the global economy gradually stabilizing and several other factors contributing to a more favorable climate for energy stocks, it might be the right time to consider investing in this sector.
But relative strength, should it kick in as it appears to now be doing, could be an ominous warning sign that inflationary pressure isn’t done. If we look at the ratio of the Energy Select Sector SPDR ETF (NYSEARCA:XLE) relative to the S&P 500, we can see some strength kicking in.
Why Energy Stocks Are Gaining Now
One of the primary reasons for the recent surge in energy stocks is output cuts by OPEC+ producers, particularly Saudi Arabia. In a strategic move, Saudi Arabia slashed its output by 1 million barrels per day in July — a move it extended through September. This marked the country’s biggest production cut in years and has significantly boosted crude prices. This reduced output coincides with a surge in travel during the summer, which has increased the demand for crude.
This heightened demand, coupled with a positive outlook for the economy as investors grow more optimistic about the Federal Reserve potentially halting rate hikes, paints a promising picture for energy stocks.
Another factor bolstering the outlook for energy stocks is the positive forward-looking guidance issued by oil companies in their recent quarterly earnings reports. For instance, Chevron (NYSE:CVX) stated in its post-earnings conference call that it expects to deliver strong free cash flow for years to come and plans to resume share buybacks through the fourth quarter. This potential signal of confidence in its upcoming financial performance is a positive sign for investors.
Moreover, there is an expectation that OPEC+ will continue to keep oil prices high, which could provide further support to crude prices. This, along with an expected increase in demand as China works to revive its economy, could offer more impetus for energy stocks.
The Bottom Line
Despite this, investing in energy stocks is not without risks, particularly if we see a reversal of the yen carry trade, which I keep emphasizing could be the catalyst for a credit event and global margin call.
In addition, if macroeconomic indicators continue to decline and central banks fail to respond appropriately, the global economy could enter a prolonged recession. Currently, the yield curve seems to suggest this is possible. This could put downward pressure on oil prices and negatively affect the performance of energy stocks.
However, on the flip side, there’s also considerable potential for reward. If oil prices reach $100 a barrel, it could result in significant gains for energy stocks and maybe allow them to diverge from broader equity indices like they did in 2022. I like the relative strength here and think oil prices can continue to move higher.
Just be mindful of the broader implications. Yes – energy stocks can continue to outperform on a relative basis, but that could just mean they go down less if things get violent for the stock market.
On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
