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Concerns over the possibility of the U.S. and other developed economies entering a recession by the end of this year or in early 2023 have grown following aggressive central bank policy moves. The U.S. Federal Reserve Board raised its short-term policy interest rate by 75 basis points last month to 1.75%, while the Bank of Canada shocked markets by raising its overnight bank lending rate by one percentage point last week, to 2.5%, the largest increase since 1994. And it’s not over yet.
Federal Reserve Chair Jerome Powell has effectively confirmed that the Fed will raise rates by at least another 75 basis points later this month and some observers are forecasting a one percentage point increase. The Bank of England has raised rates four times this year, to 1.25%, while even the European Central Bank looks set to abandon its negative interest rate policy this week.
These substantial increases reflect the sharp rise in inflation as the U.S. and the U.K. see consumer price indexes climbing at an annual rate of 9%, the highest in 40 years. Canada’s inflation rate hit 7.7% in May and and leapt even higher, to 8.1% in June. Even Germany’s inflatiion has reached 7.6%.
As central banks move to stanch inflation, fears of an economic contraction are growing, with many economists estimating that there is at least a 50% chance of recession this year and 70% chance next year. Commodity prices have sold off sharply in the last month, with the price of WTI crude oil falling over $20 a barrel (16%) to less than $100 at one point. And copper, often regarded as the metal with a Ph.D. in economics due to its use in a wide variety of industries, is down over 25%, to below $4 a pound, also in the last month. As a consequence, energy and materials stocks have been badly affected by this sharp falloff, with the S&P/TSX Energy Index and S&P 500 Energy Index off 21% and 16% respectively, while the S&P/TSX Gold Index is down 14% over the period.
However, this selloff seems to have been over-reaction on the part of investors, and may also reflect some profit-taking, given that the S&P/TSX Energy index and S&P 500 Energy index are still up 26% and 24% year to date even after the selloff compared with drops of 13% for the S&P/TSX 60 and 19% for the S&P 500 Composite Index.
Within the general selloff, some energy companies have been outperforming. For example, Royal Dutch Shell plc (NYSE: SHEL) actually up year to date, and the pipelines TC Energy Corp. (TSX: TRP) and Enbridge Inc. (TSX: ENB) also in positive territory. A number of factors continue to support the energy sector. The continuing conflict in Ukraine and sanctions affecting the export of Russian oil and gas number among the most important. Then there’s the lack of spare capacity amongst Opec members as demonstrated by U.S. President Joe Biden’s unsuccessful attempt to persuade Saudi Arabia to increase oil production.
Add the potential for weather events to increase demand both in this summer and through the coming winter, and the medium-term outlook for energy stocks remains attractive. Investors looking to enter this sector should consider major, dividend-paying integrated energy companies, such as Canadian Natural Resources Ltd. (TSX: CNQ), ExxonMobil Corp. (NYSE: XOM), Chevron Corp. (NYSE: CVX), Suncor Energy Inc. (TSX: SU), Imperial Oil Ltd. (TSX: IMO), and ConocoPhillips (NYSE: COP), all of which are likely to benefit from continued high energy prices.
With oil over $100 a barrel for most of the first half of 2022, the integrated oil companies will be delivering exceptionally strong profits when they report their second-quarter earnings later in July and early August. Many of the majors are already selling at very low price-earnings multiples, mostly under 10 times 12-month trailing earnings. For instance, Chevron is selling at 12.8 times trailing earnings, ConocoPhillips at 9.5 times, Canadian Natural Resources at 8 times, Imperial Oil at 11.7 times, and Suncor at 9.3 times. Annualizing their latest six-month numbers would mean they’re selling for less than 5 times earnings and perhaps 2 to 3 times cashflow.
These energy companies have all increased dividends to reflect the rising price of oil and gas, with yields ranging from 4.7% for Canadian Natural Resources and Suncor through 4.1% for Chevron to 2.2% for Imperial Oil and ConocoPhillips. With the share prices down 5%-12% over the last month (although still up 50%-60% over the last 12 months), this seems to be an appropriate time to consider investing in the sector. As always, consult with your financial advisor to ensure your investments align with your risk tolerance, portfolio allocation, and longer-term financial strategy.
Gavin Graham is Chief Strategy Officer of Calgary-based SmartBe Investments. He is a veteran financial analyst, money manager, and a specialist in international investing, with over 35 years’ experience in global investment management.
Notes and Disclaimer
Content © 2022 by Gavin Graham.
The commentaries contained herein are provided as a general source of information, and should not be considered as investment advice or an offer or solicitations to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication, however, accuracy cannot be guaranteed. Investors are expected to obtain professional investment advice.
The views expressed in this post are those of the author. Equity investments are subject to risk, including risk of loss. No guarantee of performance is made or implied. The foregoing is for general information purposes only. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.
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