Will Oil Stocks Once Again Lead The Market As Inflation Eases?

Key Points

• The S&P energy sector posted significant price gains Thursday on better-than-expected inflation data.
• In the past three months, energy has been outpaced by several other sectors, including materials, financials, industrials, consumer staples, real estate, and even utilities.
• Oil prices increased more than 1% Thursday, bolstered by lower consumer prices in December and growing expectations that demand in China is on the rise.
• Morgan Stanley expects that airlines will also be drivers of energy use as the post-Covid travel rebound continues. 

The ghosts of 2021 and 2022 returned to the markets Thursday as the energy sector, including oil-and-gas giants Exxon Mobil Corporation NYSE: XOM and Schlumberger Limited NYSE: SLB posted significant price gains.

The sector as a whole, as tracked by exchange-traded funds such as the Energy Select Sector SPDR Fund NYSEARCA: XLE, advanced nearly 2% in the session.

In addition to Exxon Mobil and Schlumberger, other large caps posting sizeable gains include Chevron Corporation NYSE: CVX, ConocoPhillips NYSE: COP, EOG Resources Inc. NYSE: EOG, and Pioneer Natural Resources Company NYSE: PXD.  

Thursday’s performance marked a change from how the year started, compared to 2022. Last year, energy was the leading sector, advancing 61.93%. That followed 2021’s gain of 55.71%. 

In the past three months, energy has been outpaced by several other sectors, including materials, financials, industrials, consumer staples, real estate, and even utilities, not exactly known as a barnburner of a sector. 

Oil prices increased more than 1% Thursday, bolstered by lower consumer prices in December and growing expectations that demand in China is rising as that nation reopens after Covid restrictions. 

Optimism About China Driving Gains In Oil

Thursday marked the sixth day in a row that oil prices rose. For several sessions, China's optimism was the driving factor behind increases. Not only is industrial use in China expected to increase, but analysts see a rebound in consumer travel to celebrate the Lunar New Year. It will mark the first time since 2019 that Chinese citizens are free to travel for this holiday, which happens later this month. 

Every single stock in the S&P 500 large-cap energy sector advanced Thursday. The biggest percentage gainer was natural gas producer EQT Corporation NYSE: EQT, which climbed 4.67%. 

EQT has been beaten down relative to some of its sector peers. The stock declined 22.96% in the past three months. In contrast, Exxon Mobil advanced 14.57%. True, the two stocks are in different energy industry segments, but Thursday’s large gain in EQT may indicate widespread optimism about the sector as a whole. 

Some analysts have attributed warmer-than-usual weather to EQT’s recent underperformance, as consumers and businesses have been using less natural gas for heating. 

Oil, however, is a different situation, as it’s used for a wider range of industrial applications, in addition to its most obvious use as fuel for vehicles. 

The SPDR S&P Oil & Gas Exploration & Production ETF NYSEARCA: XOP, which tracks companies involved in the ETF’s namesake industries, advanced 2.95% Thursday. The fund’s benchmark index comprises oil-and-gas stocks of various market capitalizations.

It's largest holding, by percentage, is New Jersey-based PBF Energy Inc. NYSE: PBF. The mid-cap operates refineries and a petroleum distribution network throughout the U.S.

That stock was up 2.27% Thursday, closing at $40.05. 

Morgan Stanley Forecasts Higher Oil Prices

In a Morgan Stanley report issued this week, the investment bank said it expected oil prices to increase this year due to aviation usage and increased demand from China.

The aviation case also looked good Thursday, with airline stocks, as a group, rising 4.27%. The same optimistic economic case applies here, as better-than-expected inflation data means consumers may be more ready to travel than they already have. Of course, China’s easing of Covid restrictions likely plays a role here, too.

United Airlines Holdings Inc. NASDAQ: UAL was the largest gainer in the group, advancing 3.59%. 

The upticks in oil stocks and big users, such as airlines, represent good news. But even in its optimistic report about the oil industry, Morgan Stanley cautioned that economic challenges remain. 

Earlier this month, researcher FactSet forecasted that the consumer discretionary sector would post robust earnings growth as stages an upside reversal of fortune from last year. It also predicted a decline in energy earnings. While it could still be the case that energy stocks languish, a slowdown in inflation and gradually fading Covid concerns could result in better-than-expected earnings for the energy sector.