Bank of America Merrill Lynch has become more optimistic on the energy sector, on both a small and large cap basis, as oil prices appear to have stabilized in the wake of a sharp drop that sent stock prices spiraling lower in recent months.
In a note to clients, small cap strategist Steve DeSanctis said the firm had boosted its rating on small cap energy to “overweight” from “underweight,” a move matched by Merrill’s large cap strategy team, which upgraded energy shares further up the market-cap scale to “overweight.”
DeSanctis cited an attractive valuation for the sector, a performance that has lagged behind the rebound in oil prices, analysts beginning to revise earnings expectations higher, a benefit from higher interest rates and the possibility of managers having to increase their weight in the sector due to an upcoming rebalancing by Russell Investments of its stock indexes.
U.S. crude prices bottomed out at a 6-year closing low of $43.46 on March 17, and have since rallied nearly 40 percent. By comparison, the Russell 2000 energy index has climbed slightly more than 11 percent.
When oil prices had tumbled nearly 60 percent, the energy sector fell 55.2 percent, DeSanctis noted. The index is still down about 47 percent from June 20 last year, when crude prices began to slide after hitting a nine-month high.
Among the best performers over the past month, Pioneer Energy Services Corp is up 10.9 percent and Carbo Ceramics Inc has gained 8.5 percent.
On the downside, Penn Virginia Corp and Ion Geophysical Corp have fallen more than 30 percent.
The index was up 2 percent on Thursday, on track for its biggest gain since April 29.
Despite the upgrade on the sector, DeSanctis said it “does not go without concerns, as our commodity team looks for lower oil prices in the third quarter.”
Those worries were prompted by caution over China’s economic growth and a potential rebound in the dollar. In addition, he favors names that are “exposed to oil as well as services” while being less optimistic about natural gas.
With the upgrade, energy joins small cap technology and industrials with outperform ratings by Merrill, while consumer discretionary, staples, materials and utilities are rated “underweight.”
Source: Reuters (Editing by Linda Stern and Bernadette Baum)