Vaccination efforts have begun to improve and there are some glimmers of light in healthcare data. We also are seeing evidence in alternative economic data that the economic recovery will be stronger than forecast.

So, even as the US is in the midst of winter, it seems like COVID-19 case trends have improved considerably. But the holiday distortions could still be in effect (making 7D delta look better than it actually is). However, net hospitalizations turned negative for the first time since September. This is a very good sign.

Factors in Place For “Tesla like” Rally in Energy

Strategy: FOMO Scenario: Energy in 2021 somewhat akin to Tesla in early 2020

So far, 2020 has marked the start of the rotation out of FANG into Energy and Financials. These two sectors are up 18% and 7%, respectively to start the year. FANG and Comm. Services are down about 5% and 4%, respectively. Wow.

As I wrote in my 2021 Outlook, the re-alignment of supply/demand outlook for Energy is the most dramatic of any sector. The new White House is likely to limit future supply growth. Capital availability is limited as private equity unlikely to bail out the sector like they did in 2016. And demand will certainly also recover as the global economic recovery accelerates.

And at 2.5% weight, Energy is now the smallest sector in the S&P 500. The troubles with this sector are well-known but Energy’s weighting is still tiny: GOOG, AAPL, AMZN, FB and other stocks individually have a weighting greater than Energy. And many institutions likely have a zero weighting.

Early in 2020, our clients might recall we wrote about how TSLA was likely to cause Russell 1000 Growth manager’s Fear of Missing Out (FOMO). At that time, we noted that many Russell 1000 Growth managers had a zero weighting in TSLA and their performance was accordingly suffering underperformance as the stock surged parabolically. We told our subscribers that when Russel 1000 managers went to a benchmark weighting of 0% to 0.7% that it would cause the stock to rise quickly. We believe a similar set-up is ripening for the Energy sector.

Here is how this could develop: (i) Energy stocks could surge around 20% which would drive fund manager underperformance, (ii) Energy fundamentals could improve in 2021, reversing 4 years of misery, and (iii) Valuations could improve (in case you were not aware, Energy stocks trade below replacement cost= P/B is about 1.0x which is similar to financials).

Factors in Place For “Tesla like” Rally in Energy

And looking at commodity data, energy has a lot of catching up to do. Thus, we see a catch-up trade coming and Energy remains one of our top 3 sectors for 2021 (others are Industrials and Discretionary). Just take a look at the chart nearby. Copper is up about 27% since the start of 2020. Oil is down about 5%. Energy is down 38% and Oil Services are down 39%.

Noticed the gap? We also know that Energy companies have slashed costs to achieve higher operating leverage. This is why, despite all the aforementioned bullish harbingers, we think that energy is poised to significantly outperform historical estimates based on a cost-structure that has been significantly improved as a result of the necessary ‘do-or-die’ cuts.

Additionally, our analysis of bull markets in the energy sector would suggest we are in the very early stages of one and that there is a lot of upside left in this sector for 2021. However, as we warned, Energy has the least consensus and is the riskiest of these sectors.

Taking a step back to the greater macro picture, evidence from alternative economic data sources point to the conclusion that any pullback in Q1 would be a hiatus before pent-up demand leads to what I would consider a booming economic recovery.

Even as COVID-19 spreads rapidly around the world, the global economy is staging an impressive recovery. The contemporaneous data shows this recent PMIs are surprising to the upside and many forward-looking indicators are improving. In fact, the steepening of yield curve (30 year less 10Y )is one of the strongest signals for continued strength. Our clients will recall that we have shown that since 1987 the 30Y less 10Y curve has led the ISM by 17 months. Historical data therefore suggests that there will be robust growth in 2021.

Bottom Line: We see any pullbacks that could occur through the first half of this year as pauses that will refresh in a longer-run bull market cycle that pushed equity markets higher into year end. Energy is well positioned to benefit from several structural factors that could support a “Tesla-like” reaction over the coming weeks and months.

Figure: Way forward What changes after COVID-19
Per FSInsight

Factors in Place For “Tesla like” Rally in Energy

Figure: FSInsight Portfolio Strategy Summary – Relative to S&P 500
** Performance is calculated since strategy introduction, 1/10/2019

Factors in Place For “Tesla like” Rally in Energy

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