Morgan Stanley's mea culpa on 'really bad' energy call
Morgan Stanley is finally moving off its fouled call to buy energy shares – but the investment bank can't be certain the downgrade won't align with a rebound for the embattled sector.
The US investment bank advised investors to "overweight" the energy sector at the beginning of 2015. Their thinking?
Our original thesis when we went overweight the energy sector at the beginning of the year was that they were cyclical stocks that were down a lot, you had to be anticipatory and the valuation was compelling.
It turned out to be terrible timing for the recommendation.
US crude oil prices have tumbled 16.3 per cent, while Brent, the international benchmark, has dropped 17.3 per cent, since the beginning of 2015.
The sharp decline has weighed heavily on energy shares, with the S&P 500 energy sector having lost about a quarter of its value this year.
In a note on Monday explaining its move to downgrade energy stocks from "overweight" to "market-weight," the analysts said they've altered the way they view dynamics in the industry.
Whereas analysts had looked at rig count as the key variable in determining production, it is now looking at technology employed by energy firms that allow them to keep making money - and pumping oil - at lower prices.
"It is clearer now than ever that technology has massively altered the energy landscape. Rig counts are down dramatically but production is not," Morgan said, noting companies can make the same profit margins at $60 oil today that they could at $90 oil a few years ago.
From their report:
We thought the falling rig count would be a catalyst to spark a dream of higher oil. Well, we now think rig counts aren't the way to think about it. It is production, and production isn't down really at all in the US.
While the sector rallied in February and March in anticipation of achievable estimates in April, the sector has lagged massively since because of stronger than expected supply. The valuation argument only works with a dream of a much higher oil price in the future, and that dream has been a bit of a nightmare.
Morgan Stanley reckons oil supply and demand fundamentals may not improve over the next year, meaning investors may be offered a better entry point for energy-related equities over the next six to nine months. Still, the analysts warn "this downgrade could be the beginning of an energy rally."
Morgan also said it has "seen this movie in the gas market."
Natural gas prices traded at more than five times their current value in summer 2008, but have faced pressure amid increasing production