Happy Holidays and all the best for the new year! We appreciate all your support and help in making 2022 another successful year for Siegel Asset Management (SAM) Partners.
SAM’s strategies continue to outperform year-to-date (YTD). As of November 30, 2022, SAM’s Infrastructure Income Portfolio produced a return (net of fees) of 22.7% compared to 17.7% for its customized benchmark. SAM’s ESG Infrastructure Portfolio also outperformed and generated a YTD return (net) of 12.9% vs. 10.4% for its customized benchmark. This compares to the S&P 500’s YTD return of -13.1% as of November 30, 2022.
We maintain strong conviction that traditional energy companies can prosper in the years ahead and belief in the long-term potential of clean energy stocks. SAM Partners’ objective is to provide investors with above-average income and attractive risk-adjusted returns.
A GLANCE BACK AT 2022
We had it mostly right in our Market Commentary published a year ago, “I’m Not Just Talking My Book–The Energy Sector Poised to Outperform Again in 2022.” We correctly favored value and dividend paying stocks versus growth stocks and predicted that dividends combined with even modest stock price appreciation could generate double-digit total returns of 10 to 15%. While we did not foretell a bear market, nor Russia’s invasion of Ukraine, and expected inflation to moderate more quickly than it has; we did state that “it seems prudent to expect lower market returns and elevated volatility for the S&P 500 again in 2022…”
Additional trends we anticipated include strong oil and natural gas prices, material growth in domestic renewable power and LNG capacity, energy companies remaining financially disciplined and returning cash to shareholders, and an improving narrative for fossil fuels driving energy stock prices higher.
Source: S&P Global and EIA as of December 20, 2022 KEY TAKEAWAYS:
1. Energy remained the best performing sector in the S&P 500. As of December 20th, the energy sector appreciated 54.0% YTD and, including dividends, generated a total return of 60.3% (as measured by the S&P 500 Energy Index). Earlier this year, energy stocks surpassed pre-pandemic levels. The total return over the past three years was 18.4% annualized (assuming reinvested dividends).
*Annualized return
Source: S&P Global as of 12/20/22
2. Worst year for S&P 500 since 2008. As of December 20th, the S&P 500 was down -20.0% and, including dividends, generated a total return of -18.5% YTD. The total return over the past three years was 7.6% annualized (assuming reinvested dividends).
3. Commodity prices were volatile but still up. Crude oil prices (WTI) and natural gas prices (Henry Hub) appreciated approximately 1% and 38% YTD, respectively, as of December 20th. Commodity prices were impacted by extended COVID-related lockdowns in China, dampening demand and the EU’s efforts to reduce dependence on Russian oil and gas supplies.
4. Inflation and interest rates reached multi-decade highs. In November, the consumer price index rose 7.1% year-over-year. Although inflation is still higher than it’s been in decades, it has moderated from its recent 9.1% peak in June this year. After four straight three-quarter point interest rate increases, the Federal Reserve announced a smaller hike of 50 basis points in December. Additional federal rate hikes are expected in 2023 to help combat inflation.
5. Russia’s February 24th invasion of Ukraine was a game changer. Russia essentially weaponized oil and natural gas and catapulted energy security into a top priority across global governments, most notably Europe—this, and the threat of China invading Taiwan, has led to de-globalization. Globalization facilitates the efficient allocation of resources and promotes economic growth; de-globalization does the opposite. As countries pivot toward energy security, they have accelerated investments in clean energy and energy efficiency.
6. U.S. LNG comes to Europe’s rescue. U.S. LNG exports peaked in H1’22 as facilities operated close to maximum capacity, according to the U.S. Energy Information Administration (EIA). They note that the fire-related shutdown of Freeport LNG in June impacted ~2.0 Bcf/d of U.S. LNG export capacity. The EIA also forecasts that U.S. LNG exports will establish a new record and reach 12.7 Bcf/d by the end of 2023. As cited in the European Commission website, the U.S. was the largest supplier of LNG to the EU, supplying 44% of the EU’s LNG from January through September 2022.
U.S. Annual Natural Gas Trade (Bcf/d)
Source: U.S. Energy Information Administration, Short-Term Energy Outlook, December 2022
1. The Inflation Reduction Act of 2022 (IRA) is expected to accelerate the clean energy transition in the U.S. The IRA is comprised of climate-related initiatives and energy provisions totaling ~$370 billion. This includes almost $280 billion in clean energy tax incentives.
2. ESG loses its shine. ESG-focused funds broadly underperformed in 2022. U.S. sustainable investing and clean energy stocks’ performance have both declined this year as the market pivoted toward value, and away from growth/interest rate-sensitive stocks. As of December 20th, the clean energy sector was down -4.5% YTD and, including dividends, generated a total return of -3.3% as measured by the S&P Clean Energy Index (SPGTCLTR). The total return over the past three years was 22.1% annualized (assuming reinvested dividends) as of 12/20/22.
A GLIMPSE AHEAD TO 2023 The energy sector has been the best performing sector in the S&P 500 over the past two years and is poised to continue this trend in 2023, amidst a cloudy global macro-outlook. Energy prices will likely be lower in the year ahead as storage levels improve but remain high enough to generate good returns. Strong balance sheets and robust cash flows support growing dividends and above-market yields. Energy sports a dividend yield above 3% versus less than 2% for the S&P 500. According to Evercore ISI, energy’s weighting in the S&P 500 is just 5% but it is expected to contribute more than 9% of S&P 500 earnings. Another way to look at it: while the S&P 500 trades at a P/E multiple of ~16x 2023 expected earnings, energy trades at just ~9x.
KEY TAKEAWAYS:
1. Expect modest stock market returns in 2023. Fed tightening and higher interest rates may push the economy into a recession. Consequently, estimates for S&P 500 earnings and valuation multiples are likely to be revised lower. In a rising interest rate environment, fixed income investments become more attractive relative to equities.
2. Outlook for the energy sector remains favorable. Energy stocks that pay attractive and growing dividends should compete well with alternative fixed income investments. Tug of war between growing supplies and tepid demand may lead to lower average oil and natural gas prices but remain high enough to generate attractive returns on investments. This year, the Biden administration successfully helped to dampen oil prices by withdrawing an unprecedented 230 million barrels of oil from the SPR. Storage currently sits at ~382 million barrels, the lowest level since the mid-1980s. Refilling storage in 2023 could help put a floor price on oil around $70 per barrel.
3. A recession appears likely, but its severity and duration are debatable. We believe that energy companies can weather a recessionary storm well given strong balance sheets and supply constraints.
4. Macro concerns should get resolved in the first half of 2023. The Fed tightening cycle is likely to end with the Fed Funds rate peaking around 5% and inflation should continue to moderate.
5. OPEC plus is the swing producer again. OPEC (Saudi Arabia) has remained disciplined and shown a resolve to defend oil prices.
6. EU poised to weather the storm but not out of the woods next winter. Over the past few months, unusually warm autumn weather, conservation, and record LNG imports have enabled Europe to replace Russian gas and fill storage ahead of winter. However, the International Energy Agency (IEA) suggests that there may be a shortfall of 27 billion cubic meters (Bcm) of gas next year as China’s economy reopens and diverts gas supply away from Europe, Russian imports falls to zero, and weather doesn’t cooperate. You can read the IEA report here: How to avoid gas shortages in the European Union in 2023.
European Union Gas Storage
Source: Natural Gas Intelligence calculations, GIE
7. Clean energy resolve does not abate! “The global energy crisis is driving a sharp acceleration in installations of renewable power, with total capacity growth worldwide set to almost double in the next five years, overtaking coal as the largest source of electricity generation along the way and helping keep alive the possibility of limiting global warming to 1.5 °C,” according to the IEA. You can read the full report here: Renewables 2022.
OUR INVESTMENT STRATEGIES CONTINUE TO OUTPERFORM YEAR-TO-DATE
In November, SAM’s Infrastructure Portfolio produced a return (net of fees) of 4.0% compared to 5.6% for the S&P 500 and 5.9% for its customized benchmark. SAM’s ESG Infrastructure Portfolio generated a return (net) of 4.1% vs. 7.9% for its customized benchmark. The variances from the benchmarks were primarily attributable to the SAM portfolios’ lower weightings in clean energy, the biggest outperformer in November. The clean energy sector generated a total return of 11.0%, as measured by the SPGTCLTR. The Philadelphia Stock Exchange Utility Index (XUTY) and the Alerian Midstream Energy Index (AMNAX) posted a total return of 6.9% and 3.9% last month, respectively. For November, every sector in the S&P 500 reported a positive performance, with energy posting the smallest monthly gain.
The S&P 500 Energy sector is still the best performing of the 11 S&P 500 sectors YTD with a return of 70.7% as of November month end. This compares with the S&P 500’s negative YTD return of -13.1%. YTD, SAM’s Infrastructure Income Portfolio produced a return (net of fees) of 22.7% compared to 17.7% for its customized benchmark. SAM’s ESG Infrastructure Portfolio also outperformed and generated a YTD return (net) of 12.9% vs. 10.4% for its customized benchmark.
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% and growth potential of ~7%; 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 ~3.5%. In a world starved for yield, we believe these Strategies offer a compelling value proposition.
