Oil and water may not mix, but oil and tech stocks might be the perfect combination.
By now, we all know that Big Tech is the driving force behind this bull market’s massive rise. In fact, these stocks are doing so well that calling for diversification seems like a silly move. Who needs anything else when the Technology Select Sector SPDR Exchange-Traded Fund has returned 41% since the market bottom in November 2022 and outperformed the S&P 500 by 35%? But nothing stays up forever. With the sector now accounting for a third of the market and trading near its highest valuation in more than 20 years, diversifying your bets seems like a decent idea.
Oil stocks might be the perfect complement. Indeed, their growth this year has been quite mediocre, with the Energy Select Sector SPDR ETF rising just 8.7% in 2024, well below the S&P 500's 15% gain. What's more, the group's market cap is just $1.7 trillion, just over half the size of NVIDIA, Apple, and Microsoft. And even the largest stock in the group, Exxon Mobil, has a relatively small market cap of $500 billion, making ignoring energy seem like it carries little risk and no big reward.
That would be a mistake. Oil stocks are probably the closest thing to the anti-tech stocks. Since the 2022 market bottom, the Energy Select Sector SPDR ETF has had little correlation with the Technology Select Sector SPDR or the VanEck Semiconductor ETF, and was negatively correlated with both in June, rising when tech stocks fell and falling when tech stocks rose. And this could be very helpful if tech stocks start to crash.
“Obviously the energy sector's weighting is very small so this will have a small impact on the overall market, but we think it's worth noting for investors who can take advantage of it,” wrote Jonathan Krinsky, chief market technologist at BTIG.
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Energy stocks also appear to be riding the updraft. Despite a 10% drop from its April high to its June trough, the energy ETF's 200-day moving average remains near $88, Krinsky notes, providing comfort to investors worried about further declines ahead. If the ETF can break through resistance near $91-$92, “it would signal the start of a new uptrend with targets in the upper $90s,” he writes.
Of course, more than just technicals need to come together for energy stocks to rise. The most important one is oil prices, which need to at least remain stable or even rise. WTI crude, the U.S. benchmark, is performing well, up 10% to $80.66 since hitting a low of $73.25 on June 4. And there are good reasons to think the rally will continue. JP Morgan strategist Natasha Kaneva and her team point out that oil demand remains strong, refineries are running at full capacity, and seaborne oil exports from OPEC are at a two-year low. If their predictions are correct, European benchmark Brent crude will average $84 in the third quarter of 2024 before hitting a high of $90 in August or September.
This would be very bullish for the Energy Select ETF and oil stocks, which have held their 200-day moving averages during the recent sell-off, including Warren Buffett favorites Kotera Energy, EOG Resources and Occidental Petroleum.
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Exxon Mobil is in this group, and it looks especially attractive. On Tuesday, UBS analyst Josh Silverstein named it “the best stock to own for the next five years” in his region. The reason is quite simple: Exxon should be able to grow earnings and return capital even if oil prices don't rise.
That's due in part to the strength of its refining division, the company's planned $5 billion in cost cuts, new oil projects that could add $4 billion to earnings, a strong balance sheet that will allow it to continue paying dividends and buying back shares, and even low-carbon investments that could lead to increased earnings starting in 2028. Ultimately, the company's shares could rise 35% to $154 from a recent $114.41. However, the stock is trading at 10 times free cash flow, the company's historical average.
And that's something that can't be said about Big Tech.
Contact Ben Levisohn at Ben.Levisohn@barrons.com.
