Deutsche Bank’s David Bianco, like many of his peers, thinks the bull market in stocks still has some life in it.
His call is for the S&P 500 to hit 2,250 by the end of 2016. That implies a roughly 10% rally from today’s levels.
But not every sector excites him.
In particular, Bianco isn’t a fan of the energy companies, especially those exposed heavily to oil prices.
“Energy is a value trap,” he writes.
This is an interesting call, as it is tempting to conclude that the bad news for energy companies is priced in. In the wake of last year’s oil crash and this year’s persistently low prices, energy stocks have been slammed. The Energy Select Sector SPDR ETF (XLE) is down over 20% this year, which compares to a relatively flat S&P 500.
For Bianco, the assumptions that are implied by energy stock valuations continue to be too aggressive.
“At Energy’s current ~$1.3tr market cap, market-implied normalized Energy earnings are $90bn in 2016, if a fair forward PE on normalized earnings is assumed to be 15x,” he explained. “$90bn+ of normalized earnings would imply that either an 80% gain in profits will occur on a ~40% gain in oil price (to $65-70) for the entire sector, or that the market assumes oil prices will normalize above $65-70/bbl.”
Sure, $65-70/bbl for oil is low relative to levels we saw just a year ago. During the summer of 2014, WTI crude was priced at around $110.
However, the WTI crude is trading at around $36 today, which is a long ways to go.
Bianco sees at least three more major hurdles to achieving higher oil prices. From his note (verbatim):
1) Oil service profits are likely to stay very weak given the capacity rationalization likely needed to get oil prices to $65-70/bbl.
2) Natural gas prices are likely to stay very depressed for a long time.
3) Oil refining margins would suffer a big hit should oil prices rise to $65- 70/bbl without a large WTI to Brent price spread.
Simply put, Bianco thinks there could still be a lot more pain to be had in this sector.
So in this environment, he’s recommending clients to stay underweight energy. He’s also recommending clients be underweight industrial capital goods stocks. Meanwhile, he’s bullish on health care, tech, and utility companies.