Peak Oil?

Within certain sectors, there are longer-term themes that are consistently in the background having some measure of influence on our recommendations. For example, the aging population of the American public is something we have to watch when considering how to adjust our health care recommendations. It’s one of those issues that we often get asked about with regard to the energy sector, on which we currently have a marketperform rating. The concept of peak oil is often brought up in response any time we downgrade our view of the energy space.

Peak oil is the point at which crude oil production begins to decline toward a terminal level. As most people know, oil is a finite resource and, at some point in time, will theoretically be used up. The belief is that at some point in time, many people believe around now, all of the available oil will be found and production will begin its inevitable decline to zero. Based on that theory, those who believe peak oil has already occurred believe that oil prices will move ever higher, resulting in a consistently bullish outlook on the energy space.

As we've noted, we tend to have a bullish lean toward the energy space over the longer term as we believe expanding emerging markets will continue to increase their demand for energy. However, we believe it's an overstatement to say that we have reached the point of peak oil production. Certainly, many of the easier, cheaper sources of oil have been found, but that doesn’t mean there isn't still more to find. New technologies in exploration and extraction have opened up new sources that were unimaginable even just a decade ago. Additionally, environmental issues have prevented exploration in some of the more promising areas around the Americas, where there is likely more oil to be found. Of course, in the end, no one knows for sure when peak oil will be reached and how markets will react.

For investors, we suggest that peak oil is something to keep in the back of your mind but that it plays little relevance for tactical positioning. Energy markets move with much shorter term events in mind, such as global conflicts, economic conditions, and currency movements. Finally, it is not an inevitability that we run out of oil. There will almost certainly be a response as prices rise in the form of new energy sources and reduced demand for oil. As a result of all of these factors, we encourage investors to take the predictions of a dire future for energy production with a grain of salt, and focus more on things that are more visible and concrete. With demand still likely to remain relatively robust, although growing at a more subdued rate, we don’t believe a further downgrade of the sector is warranted but are remaining at marketperform for the time being.

In terms of other sectors we are maintaining consumer discretionary and materials at underperform. With consumer discretionary we want to note that this does not mean we think that consumer spending is going to fall off a cliff, but that there are challenges that we believe will weigh on the sector in the near term. The first reason for this belief is the larger view of where we believe we are in the economic cycle. As a so-called 'early cyclical' group, the consumer discretionary sector tends to perform well at the initial stages of an economic recovery, much as we saw during this recovery. At this point, we believe we're well past that and into a maturing phase of economic expansion, where investors may look to rotate money out of the discretionary sector.  As for materials, this group has rebounded a bit as of late, but we believe it's too soon to upgrade the sector. Central bank tightening and fiscal cutbacks could affect growth rates, potentially reducing the near-term growth prospects for the materials group.

At the other end of the spectrum, health care and information technology continue to maintain outperform ratings. The healthcare sector has been the best performing sector over the past three months and year-to-date, as the seemingly stable group appears increasingly attractive to investors concerned about the economic environment going forward. For information technology, with large cash balances, increasing dividend payments, solid management and tight inventory controls, the sector is far more stable than it was in the late 1990s environment that so many still remember. Despite some occasional blips in technology due to growth scares, inventory concerns, and supply chain issues, we've been touting this stability as one of the reasons to stick with the group. We believe those who remain invested in tech will be rewarded with outperformance in the coming months.

We also continue to hold a marketperform rating for financials, industrials, telecoms, utilities and consumer staples. Our recommendations can and do change quickly at times as we continually monitor economic progress and specific factors influencing individual sectors.

Kully Samra is UK branch director at Charles Schwab.

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