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- The sharp outperformance in energy stocks this year is likely to continue, JPMorgan said in a note on Thursday.
- The bank named the energy sector as one of its favorites and said it offers an attractive risk vs. reward profile.
- These are the 3 reasons why JPMorgan is advising its clients to invest in energy stocks.
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It's not too late for investors that missed out on this year's best-performing sector to gain some exposure, JPMorgan said of energy stocks in a note on Thursday.
The energy sector is up about 50% year-to-date, nearly triple the S&P 500's 17% gain over the same time period. But there's still room for energy stocks to play catch-up to the broader market when looking at a longer time horizon, the bank noted. Since 2014, the energy sector is lagging the broader market by a whopping 183%.
JPMorgan sees gains continuing for energy stocks as a supply crunch pushes oil, natural gas, and even coal prices through the roof. Those prices could continue to creep even higher, as JPMorgan sees oil potentially surging to $130 per barrel.
The energy sector offers an attractive risk vs. reward profile to investors thanks to three key reasons: low valuations, improving fundamentals, and increasing capital returns, JPMorgan said.
In fact, valuations of energy stocks are so low that the sector represents only about 3% of the S&P 500 today, down from about 20% at one point, the analysts noted. That leaves significant runway for the sector to increase its value as favorable economics wash over energy companies amid a surge in oil prices.
"As is usually the case with commodities, we expect the energy recovery to be swift and more extreme than post-bust rebounds seen in other asset classes such as commercial real estate during the 1990s, dot.com during the 2000s, and financials/housing during the 2010s," JPMorgan said.
The bank said investors looking for the most upside potential in the sector should buy small-cap energy stocks. That's because they have higher sensitivity to rising oil prices, are undergoing a balance sheet recovery, and are potential merger targets as larger peers look to build up their reserves.
And many of the risks that have scared investors out of energy stocks over the past few years, like regulations, the rise of ESG investing, and a surge in electric vehicles, are actually catalysts for buybacks and dividends.
Those factors are "helping bring much needed discipline to the sector with a focus on reducing debt and returning excess shareholder capital rather than higher market-share and production," JPMorgan said.