A JPMorgan analysts has been terribly wrong in his bullish energy sector outlook, but like a broken clock that is right twice a day, that call may be coming into focus, writes Landon Whaley.
This week’s “Headline Risk” comes courtesy of J.P. Morgan, who has been touting energy stocks throughout the ongoing Winter Fundamental Gravity environment in the United States. The headline risk is real as J.P. Morgan (JPM) makes several classic, Old Institution mistakes in their recommendation to be long energy explorers and producers.
On April 5, J.P. Morgan analyst, Dubvrako Lakos-Bujas, made a bullish call on energy stocks because “valuation for the energy sector is at a multi-decade low…and there’s strong earnings-growth potential...” Lakos-Bujas went on to say, “Energy currently offers the best risk-reward, in particular, higher beta plays such as Exploration & Production...”
There is nothing the Old Institution loves more than a market call based on valuations. Folks, valuations are not a catalyst for directional movement in a market. However, once a bullish (or bearish) move begins, low (or high) valuations can be an accelerant that adds some oomph behind the bullish or bearish trajectory.
Unfortunately for Lakos-Bujas, he learned the hard way that valuations at multi-decade lows can go a lot lower when the market in question is enveloped in a bearish Fundamental Gravity. From his April 5 call, until he reiterated his call on Sept. 26, oil and gas explorers declined 28.4% on a cumulative basis and experienced a drawdown of 37.8%.
In short, “cheap” energy stocks got even cheaper.
Not only that, but his “strong earnings growth potential” catalyst didn’t work out either. Energy companies in the S&P 500 reported Q2 2019 earnings growth of -2.1%. So far, for Q3 earnings, the energy companies that have reported have an aggregated earnings growth rate of -17.6%. The energy sector is not displaying “strong earnings growth” and with two consecutive quarters of contracting growth now under its belt, energy is in an outright earnings recession.
In the Sept. 26 report, Lakos-Bujas doubles down on his bullish bias for energy explorers and producers, citing “investor complacency” and the Middle East as a “geopolitical tinderbox” as reasons why investors should attempt to catch a falling knife.
Just like valuations, investors’ perception of a market and geopolitical considerations aren’t primary drives of asset prices, at least not beyond a few hours or days.
In the month since Lakos-Bujas reiterated his bullish call, oil and gas explorers have declined an additional 7.0% and experienced an intra-month correction of 10.0%.
The headline risk bottom line is that J.P. Morgan has been reiterating a bullish call on energy stocks for the last seven months based on valuation, sentiment, and geopolitical risk. None of those proposed catalysts have moved the profitability needle, but why not?
Because those things don’t dictate the bullishness or bearishness of a market, that’s the job of the prevailing Fundamental Gravity. Here in the United States, we’ve been in a Winter Fundamental Gravity, and in those environments, oil and gas explorers only post positive returns 25% of the time, the average three-month returns of -10.5% and experience average drawdowns of 22.4%. Do those performance stats ring true since April, or what?!
As we discussed in this past Monday’s Gravitational Edge playbook, we are beginning to evaluate opportunities in both energy stocks and crude oil, but that’s because inflation is starting to accelerate. This directional change in inflation shifts the United States out of a Winter FG and into Fall, which is a very bullish environment for crude oil and crude-related equities.
When you align your positioning with the prevailing Fundamental Gravity environment, you don’t have to worry about getting body-bagged like the poor saps following J.P. Morgan’s advice.
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