Sector Analysis - ENERGY

Energy stocks have been the market darlings of the past few years as financials have become the black sheep of the investing world. Between 2000 and 2007, energy outperformed the S&P each year EXCEPT one (2003). Between 2004 and 2007, energy was the single best sector in three of those four years.

Although there is clearly a thesis to be made for rising oil prices on the backs of a future economic recovery and energy stocks are likely to play a clear role in the global demand that will one day return, it is going to be increasingly difficult to follow up that kind of outperformance. This doesn't mean energy stocks have to go down, it just means there is potential for returns from the energy sector to be less than what the market will return in the coming years.

Like the financials, energy is now reaching peak levels as a percentage of the S&P. As of January 30th, the energy sector represented over 14% of the S&P versus an average since 1990 closer to 9%. As of March, energy stocks have already drifted to 13% of the S&P.

As you will see from the chart below depicting energy as a percentage of the S&P since 1990, 1999 was the opportunity to buy energy stocks at only 5.60% of the S&P. That was the chance to pick up energy shares and enjoy years of outperformance relative to the market. Now we find energy at the opposite end of the spectrum near its highs as a percentage of the S&P.

Sure, it could always go to 15% or 16%, etc, but at a minimum the risk/reward for the energy sector as a whole is clearly tilted towards risk at this stage of the game.