The energy sector is on the rise according to a recent report from Morgan Stanley. After underperforming the broader market since September, the sector is now showing signs of strength and could be poised for a comeback. In a recent upgrade, strategists at Morgan Stanley led by Michael Wilson recommended overweighting the energy sector as they anticipate a broader market rally that could rotate into energy stocks.
Wilson believes that we are currently in a late-cycle market environment, which historically favors energy outperformance. Despite being the best performer over the past month, energy stocks are still lagging behind the rally that began in October. Wilson highlighted that energy stocks have actually contributed more to the change in S & P earnings since the Covid-19 pandemic than any other sector.
To play the potential comeback in the energy sector, Morgan Stanley recommends investing in companies like ConocoPhillips, Devon Energy, Occidental Petroleum, and Diamondback Energy. While energy stocks have lagged the price of crude oil this year, Wilson believes that the gap will close, as suggested by the increase in crude prices year over year.
Additionally, earnings revision breadth for energy stocks seems to be moving in a positive direction, and the sector’s free cash flow margins, though down over the past two quarters, are still above historical averages. The net debt of the energy sector compared to earnings before interest, taxes, depreciation, and amortization is also below historical averages dating back to 2010.
Overall, the energy sector is showing signs of promise after a period of underperformance. With potential for earnings growth and a market rally that could rotate into energy stocks, now may be a good time to consider investing in this sector.
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