The disparity between the energy sector's market cap weighting and its earnings contribution to the Standard & Poor's 500 stock index has increased steadily over the past five years, and the "enormous" shift in wealth that is flowing into the sector is a sign that could mean a long-term rotation into energy stocks over the next five to 10 years, analysts said.
Raymond James & Associates Inc.'s J. Marshall Adkins and Pavel Molchanov said in a note to clients that not only are investors underweight on energy stocks, but they are "materially underweight," and this is despite the energy sector's "huge bull run" for the past five years.
"For this reason, we believe energy weightings in the market are likely to continue trending upward in the coming years," the analysts wrote.
Adkins and Molchanov wrote that from the 1980s through the early part of this decade the actual weighting of energy stocks as a percentage of the S&P 500's market cap was in a "steady decline, falling from a peak of 28.1% in 1980 to a low of 5.3% in 1999 -- a drop of more than four-fifths." Since 2002, however, the exploration and production index of the S&P 1500 has outperformed the S&P 500 for four of the past five years. The energy sector's current market cap in the S&P 500 is at 10.6%.
"Despite the impressive energy stock gains in recent years, today's energy weighting is still lower than the 30-year average of 11.5% by nearly 100 basis points, and this strongly suggests that investors are underweight energy relative to long-term historical averages," wrote the analysts. "Given our thesis that long-term energy fundamentals are very bullish relative to the overall market, we are convinced that energy weightings will continue to move upward over the next five to 10 years."
Current energy earnings may not be sustainable, "but earnings growth from energy companies should continue to outpace the rest of the market for the foreseeable future. The only fundamental difference we see with regard to 2008 and 2009 versus the past few years is that energy earnings growth should be driven predominantly by oil rather than gas, as least for North American companies."
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