Market Commentary: End of Year Wrap-Up (I’m Not Just Talking My Book)
Happy Holidays and best wishes for a happy, healthy, and prosperous new year! Thank you for your support and help in making 2021 a successful first full year for Siegel Asset Management Partners. We look toward the future with high conviction that the best is yet to come!
I’m Not Just Talking My Book – The Energy Sector Poised to Outperform Again in 2022
It was another great year for investors with the S&P 500 likely to finish at or near-record highs driven by strong GDP growth of more than 5%, fiscal stimulus and low interest rates. Energy was the best performing sector by far, but its performance over the past three, five, and ten years has been dismal, especially when compared to the broader stock market (please see tables below). We see the tide turning as the energy industry transitions to a new business model of generating free cash flow and returning cash to shareholders, as well as embracing the path to decarbonization.
While we’re not anticipating a market downturn, it seems prudent to expect lower market returns and elevated volatility for the S&P 500 again in 2022 given lofty valuations, likely headwinds from Fed tightening, higher interest rates, and stubborn persistence of COVID-19 and its variants. Against this backdrop, we believe that value style investing can outperform growth. At our core, we are value investors and favor dividend paying stocks. Dividends combined with even modest stock price appreciation can generate double-digit total returns of 10 to 15%. As such, we anticipate that the energy sector can once again outperform in the coming year and are optimistic that our Infrastructure Income and ESG Strategies can deliver attractive total returns for our clients.
THE TIDE HAS TURNED FOR THE ENERGY SECTOR
Source: S&P Global and Bloomberg
LOOKING BACK AT 2021:
▪ The stock market crushed it. COVID-19 and inflation fears may have stolen the headlines, but stocks were propelled higher by “free money” and fiscal stimulus. As of November 30th, the S&P appreciated 21.6% and including dividends generated a total return of 23.2%. The cumulative total return over the past three years is 74.4%.
▪ Stock buybacks set new record in the third quarter. According to preliminary data from S&P Dow Jones Indices, companies in the S&P 500 repurchased $234.5 billion in shares during Q3’21, surpassing the previous record of $223 billion in Q4’18.
▪ Energy was the best performing sector in the S&P 500. As of November 30th, the energy sector appreciated 43.5% and including dividends generated a total return of 49.8%. However, energy stocks are still below pre-pandemic levels. The total return over the past three years is a negative 3.0% (assuming reinvested dividends).
▪ Commodity prices surged. Crude oil prices (WTI) and natural gas prices (Henry Hub) appreciated 36.4% and 79.9%, respectively, as strengthening economic activity drove higher demand and global inventories decreased.
▪ Inflation reared its ugly head. Federal Reserve Chairman Powell has stopped using “transitory” to describe inflation. In November, the consumer price index rose 6.8% year-over-year.
▪ It’s all about ESG – Environmental, Social, and Governance reports have become ubiquitous on corporate websites. ESG scores are now part of the criteria investors must consider in their investment decisions.
▪ Global warming continued to garner a lot of attention! Progress was made at the recent United Nation Climate Change Conference (COP 26). However, country decarbonization pledges and today’s technologies are insufficient to meet aspirational goals of net zero by 2050.
▪ The continued need for fossil fuels gained recognition. Energy crises in U.S., Europe, and Asia are reminders that the world is not yet ready to abandon fossil fuels. Mike Wirth, Chevron CEO, echoed this sentiment in his remarks at The World Petroleum Congress in Houston: “The world needs our expertise and experience to successfully reduce emissions while preserving economic prosperity.” This is also reflected in an excellent letter from EQT’s President and CEO, Toby Rice, to Senator Elizabeth Warren regarding the role of natural gas in reducing greenhouse gas (GHG) emissions (click here to read).
▪ Energy companies got the message. Generate attractive returns, lower leverage, produce free cash flow and return cash to shareholders. In addition, set GHG emissions reduction targets and issue Sustainability (ESG) reports.
LOOKING AHEAD TO 2022:
▪ Expect lower market returns in 2022. Higher interest rates may be a headwind for growth stocks. Growth stocks, such as clean (or alternative) energy may underperform because the present value of future cash flows will be worth less given higher interest (discount) rates.
▪ Play defense with utilities. Utilities have historically initially underperformed when the Fed starts tightening but outperform as the cycle is extended. Even with higher interest rates projected, we favor exposure to selective utilities because of their defensive qualities, attractive dividend yield, five to eight percent growth potential and transition to renewable power such as wind and solar.
▪ Growth in renewable power capacity is set to accelerate. It is projected to reach more than 4,800 gigawatts (GW) and surpass the combined capacity of fossil fuels and renewables over the next five years, according to the International Energy Agency. China will account for 43% of the growth followed by Europe, the U.S., and Asia. These four countries will account for 80% of the growth in renewable power generation.
▪ Inflation is likely to moderate as supply chain bottlenecks abate, fiscal policy is restrained, and central banks begin tightening.
▪ Midstream companies are likely to accelerate dividend growth and share repurchases as balance sheets have been restored to health and they continue to generate free cash flow.
▪ Energy companies remain financially disciplined and allocate more capital to decarbonization (e.g., renewable power, renewable natural gas, carbon capture and sequestration and hydrogen).
▪ Oil and natural gas prices look to stay strong with risk to the upside.
▪ OPEC + stays the course. The cartel and friends remain on pace to raise monthly production by 400,000 barrels per day through April 2022.
▪ U.S. becomes the global leader in LNG export capacity. U.S. peak export capacity of 13.9 Bcf/d will be the highest in the world by year end 2022 surpassing both Australia (11.4 Bcf/d) and Qatar (10.4 Bcf/d). For context, U.S. natural gas production in December 2021 is expected to set a record high and average 97.5 Bcf/d. (Source: EIA)
▪ The narrative against fossil fuels begins to improve and could be a catalyst for higher stock prices. We believe that it will become more apparent that traditional energy will always be vital to support human welfare and is required to achieve a decarbonized future. Multiple global energy crises in 2021 underscore the importance of reliable and affordable energy.
Black Friday Derails Energy
The World Health Organization’s (WHO) classification of Omicron COVID- 19 as a variant of concern (VOC) on Black Friday (November 26th) pushed equity and commodities markets lower. While stock markets have recovered (the S&P 500 reached a new high on December 10th), commodities are still well off their recent peaks. To be fair, oil prices began to fall earlier in November, due to easing of the energy crises in Europe and Asia. Then on Black Friday, oil prices cratered and the price of West Texas Intermediate (WTI) fell by more than $10 per barrel (13.0%) to close at $68.15. Concerns about possible lockdowns impacting global crude demand were exacerbated on Tuesday, November 30th when Federal Reserve Chairman Jerome Powell told the Senate Banking Committee that the Fed will consider accelerating the tapering of its asset purchases by a few months.
As of this writing (Black Monday), WTI has once again fallen due to the rapid spread of Omicron and announcements of temporary lockdowns in Europe. If the experts are correct and Omicron infections peak in January, we expect oil prices to rise back above $70 per barrel and may have indeed found a bottom on December 1st at $65.50 per barrel.
On November 23rd, the White House announced the release of 50 million barrels of crude oil from the Strategic Petroleum Reserve (SPR) after unsuccessfully pleading with Saudi Arabia to increase production. The symbolic release of oil from the SPR will represent less than three days of U.S. production and is unlikely to move oil prices, in our view. To note, the Strategic Petroleum Reserve was established in the 1970s for emergency use and not to manage prices.
At its Ministerial Meeting on December 2nd, OPEC + decided to stay on plan and adjust its monthly overall production upward by 400,000 barrels per day (bpd) for the month of January 2022. They were able to calm markets by remaining flexible and keeping the meeting in session to continue monitoring the market for any deleterious impact from Omicron.
Omicron Fears Weigh on Energy and SAM’s Portfolios in November
In November, SAM’s Infrastructure Portfolio produced a negative return of 4.2% compared to -0.69% for the S&P 500, but outperformed its customized benchmark, which declined 5.9%. Year-to-date, our strategy has outperformed both the S&P 500 and its benchmark with a total return of 27.5% compared to 23.2% and 19.9%, respectively. The biggest losers in November were the clean energy stocks that generated a loss of 7.1%, reversing nearly half of the prior month’s impressive 16.5% return, as measured by the S&P Clean Energy Index (SPGTCED).
The S&P 500 Energy sector posted a one month return of -5.2%, but year-to-date is still the best performing of the 11 S&P 500 sectors with a 49.8% total return. Still, after such stellar performance, Energy is the only S&P sector that is still below its high, reached in January of 2020. The Alerian Midstream Energy Index (AMNA) and the Philadelphia Stock Exchange Utility Index (UTY) posted negative returns of 7.1% and 1.3%, respectively, last month. SAM’s nascent ESG Infrastructure Portfolio generated a negative 3.9% total return in November weighed down by its holdings in the midstream and clean energy sectors.
Source: S&P Global, NASDAQ and Alerian
Sam Partners’ Infrastructure Income and ESG Infrastructure Strategies seek to provide sustainable income and growth with capital preservation. This is accomplished by investing in a concentrated portfolio of high-quality clean energy companies, midstream energy companies and utilities that are well positioned to participate in the energy transition to a net zero carbon future. A diversified approach to investments across these sectors should optimize risk-adjusted returns, in our view. Our Infrastructure Income Strategy offers investors a current yield of ~5.5% and growth potential of ~4%; while the ESG Infrastructure Strategy that is more heavily weighted with clean energy stocks and adheres to strict ESG criteria, offers investors a current yield of ~ 3%. In a world starved for yield, we believe these Strategies offer a compelling value proposition.