After vastly underperforming the S&P 500 earlier in the year, energy stocks have generally outperformed since mid-August. We attribute this to the rise in oil prices since June and market sentiment becoming more bullish that oil prices will rise in coming months. Part of this is an improved global demand outlook (led by the U.S. and developing economies) as well as supply stabilizing, led by ongoing OPEC and Russian cuts and expectations for oil shale growth in the U.S. to slow. In addition, we believe there has been some rotation back into energy with investors seeing good value, given the sector lagged so significantly the first eight months of the year.
Even though most energy stocks were up 10% to 20% over the last month, energy remained the worst-performing sector in the S&P 500 this year, suggesting that it remains attractive. While oil prices have risen above $50, to levels not seen since early this year, we expect prices will continue to rise in coming months, with robust global demand growth and disciplined investment by producers around the world that will keep supply from growing too fast. Rising oil prices tend to lead energy stocks higher, just as we have seen lately.
We believe the range of $55 to $65 per barrel is where oil prices will be most of the time going forward. We have been below this range for quite a while, but we see oil prices reaching the bottom of the range in mid-2018 and reaching the $60 midpoint by early 2019. The downturn in oil prices has instilled greater discipline across the industry that we believe will add value over time with greater focus on cash flow, controlling costs and financial flexibility.
In the third quarter, commodities (which include energy) were the best-performing asset class, and energy posted the best sector performance in the S&P 500. That's why we recommend keeping a diversified equity portfolio with appropriate exposure to all sectors, including 9% in energy. To keep portfolios in balance, you may need to add asset classes or sectors that have lagged and trim those that have outperformed. Our broader view of commodities is cautious, however, and we have a "low" target allocation because we think the outlook for demand growth remains low compared to supplies, and the risks outweigh the expected returns.
This article was written by Edward Jones for use by your local Edward Jones Financial Advisor - Jeremy Raverty. The local Edward Jones office in Prescott is located at 1400 N. Acres, Suite 55.