In our investment management experience, investors fall into one of two camps when looking at an investment that has dropped in price significantly. Investors in the first group steer clear, not wanting to “catch a falling knife” as the old Wall Street adage warns. They can be described as trend-following investors. However, the second group of investors sees opportunity in a depressed price. These are the value investors.
With the S&P Energy Sector off over -20% from its all-time high set just about a year ago, how should you view beaten-down energy stocks? Should you take the value approach and look for opportunity? Or should you stay away, expecting the sector to continue to underperform?
If you rely on history, you should expect the latter. According to Ned Davis Research, after major bottoms in the price of oil (which we believe occurred in March), oil prices tend to recover and continue upward, but energy stocks tend to outperform the broad stock market for a couple of months before starting to underperform again.
This time around, energy stocks have followed the historical pattern almost identically. After oil’s bottom in March, energy stocks outperformed the stock market for one and a half months before underperforming again. As a result, we continue to recommend avoiding energy stocks despite the recovery in the price of oil.