In February, we had some energy positions called away profitably. With talk of a summer gas spike occurring, we
did not want to risk being out of energy stocks because profit margins of
energy stocks generally increase when oil prices rise. So, we fairly quickly re-established these
positions shortly after options expiration in February. However, later in February, reports of the ill
effects of higher energy prices on weak economies around the globe became the
focus and sent energy futures prices, and energy stocks, down.
The cyclical energy sector then became a primary target for
the risk shedding that occurred after the elections in Greece and France
triggered the current “risk off” environment we wrote about in our previous
post. As a result, the energy sector is
the worst performing sector of the S&P 500 year-to-date through June 8.
In some accounts we also own Halliburton (HAL), a premier
oil services sector company. This sector
has declined in sympathy with the price of oil but has also been affected by a
price spike in a compound used in the fracturing process that has put more
pressure on margins. The stock closed at
$27.96 on Friday.
We believe the energy sector in general is one of the most
undervalued sectors, and HAL is extremely cheap, trading at a PE ratio of
nearly half of its 5-year average (8.3 vs. 15.5) and only 1 times sales. The analyst consensus price target for HAL is $46. We received some confirmation on our opinion
this morning when Goldman Sachs issued a forecast for a 29 percent rise in
commodity prices over the next 12 months to be led by the energy sector. (We do find, however, the extreme confidence
of these specific point estimates of Wall Street forecasts somewhat amusing.)
Also, OPEC meets later this month, and the Saudis are going
to be under pressure to cut their production.
A number of the smaller OPEC members are facing production costs that
are currently higher than the current spot oil price. Our approach after June options expiration is
to write calls on energy positions using options further out-of-the-money, if we
sell options at all, to capture the upside of this undervalued sector.
On the positive side, our largest portfolio exposure is in
the information technology sector which leads the S&P 500 Index
year-to-date, and we’ve been able to buy back June options and roll down to
lower June strike prices on numerous positions including energy stocks/ETFs for
many accounts. Despite a positive week
for most equity markets last week, we don’t believe this is the start of a
“risk on” environment as too much uncertainty exists with elections in Greece
occurring after June options expiration next weekend. However, news that euro zone finance
ministers agreed to lend Spain 100 million euros to help the country’s shaky
banks reduces the risk of contagion. We
believe a “risk on” environment could come sooner rather than later once there
is more clarity with the political situation in Greece.
As always, please contact us if you have any questions.
