- Concerns about overpriced growth and large-cap stocks have left the market in a holding pattern.
- The energy sector has been the top performer this year.
- Sean O'Hara recommends considering the sector, which trades at a lower price-to-earnings multiple.
The stock market is in a bit of a holding pattern right now.
Some investors worry that growth and large-cap stocks are too expensive. Any sudden and negative news could pull back a major technology company's stock and even drag down the broader market, which has been heavily concentrated around the magnificent seven.
One popular opinion among fund managers is that investors will favor mid and small-cap value stocks as the Fed cuts interest rates. So far, those cuts have been pushed back, initially expected in March and then in June. But since inflation came in hotter than expected for March, whether rates will drop this year is now also in question. So far, the S&P 400, a benchmark for mid-caps, is only up by 4.75% for the year, while the S&P 600 for small caps is down by 1.87%.
Suppose you're on the sidelines, wondering where to deploy cash for some alpha. In that case, you should consider the energy sector, says Sean O'Hara, a 30-year market veteran and president of Pacer ETFs, which has a series of passively and actively managed exchange-traded funds to navigate turbulent markets.
He said that this year, the outlook for oil, gas, and energy stocks is quite good from an equities perspective, especially when compared to the broad market, which looks a bit rich. This makes it a great hedge. Energy has been the best-performing sector this year: the S&P 500 Energy Sector index is up by 15.4% compared to the S&P 500, which is up about 7% for the same period.
Energy stocks also trade at a low price-to-earnings multiple compared to the market. As of April 25, the energy index had a P/E ratio of 12.72, compared to the S&P 500 at nearly 25.
Depending on where the oil is coming from, the cost to produce a barrel could be as low as $20, O'Hara said. Therefore, if oil is trading at $80 a barrel, it's generating an enormous amount of free cash and free cash flow yield, he added. West Texas Intermediate crude oil, a US price benchmark, settled at $83.85 on Friday and has climbed nearly 19% this year. O'Hara believes energy prices will remain elevated, with geopolitical risks coming from the Middle East between Iran and Israel and continued tensions between Ukraine and Russia, he noted.
Energy stocks
To gain exposure, investors can opt for energy-based exchange-traded funds or those that track the S&P 500 Energy sector companies. One example is the Energy Select Sector SPDR Fund (XLE).
O'Hara filters his stocks within his actively managed ETFS based on their free cash flow (FCF), which is a company's leftover cash after subtracting what it needs for operations and capital expenditures. The Pacer US Cash Cows 100 ETF (COWZ) has a large exposure to energy stocks this year because of their high cash flow. Below are the top 10 energy names from the fund.
Ticker | Energy company |
LNG | Cheniere Energy, Inc. |
DVN | Devon Energy Corporation |
MRO | Marathon Oil Corporation |
EOG | EOG Resources, Inc. |
XOM | Exxon Mobil Corporation |
FANG | Diamondback Energy, Inc. |
OXY | Occidental Petroleum Corporation |
CVX | Chevron Corporation |
VLO | Valero Energy Corporation |
MPC | Marathon Petroleum Corporation |
