Bull Market for Stocks Signaled by Oil Producers Valued at 19 Times Income

Investors in oil shares are more bullish on the U.S. economy than any time in the last eight years, convinced the biggest decline in equities since the bull market began will prove a buying opportunity.

The 39 energy producers and equipment makers in the Standard & Poor’s 500 Index have traded at an average 19.1 times earnings in 2010, compared with 17.8 for the index. The last times they had higher valuations in 1994, 1999 and 2002, the benchmark gauge for U.S. stocks surged an average of 22 percent in the next year, according to data compiled by Bloomberg.

The premium shows investors expect the global economy will expand fast enough to boost fuel demand even after Europe’s debt crisis and a breakdown in American markets on May 6 wiped out $1 trillion of U.S. equity value last week, according to data compiled by Bloomberg. The $585 billion combined market value of Exxon Mobil Corp. and Beijing-based PetroChina Co. exceeds the gross domestic product of Greece and Portugal put together.

“We’re just experiencing a needed correction, a resetting of expectations,” said Alan Gayle, a money manager at RidgeWorth Investments in Richmond, Virginia, which oversees $63 billion. “Because we still believe the economy is turning the corner and expansion is going to continue, we have a pro-market bias. I see the market as evolving into more of a buying opportunity.”

Photographer: Jason Janik/Bloomberg

Gas pumps sit at an Exxon Mobil Corp. filling station. Close

Gas pumps sit at an Exxon Mobil Corp. filling station.

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Photographer: Jason Janik/Bloomberg

Gas pumps sit at an Exxon Mobil Corp. filling station.

Market Plunge

The S&P 500 lost 6.4 percent to 1,110.88 last week, wiping out its 2010 gain and leaving it down 8.7 percent since its 2010 high on April 23, according to data compiled by Bloomberg. Stocks surged today, with the S&P 500 climbing 3.9 percent to 1,154.2 at 10:36 a.m. in New York, after European policy makers unveiled a loan package worth almost $1 trillion and a bond purchases to stop the sovereign debt crisis.

While oil earnings increase the fastest when the economy expands, they can evaporate when growth stalls. The Washington- based International Monetary Fund, which is helping finance the 110 billion-euro ($140 billion) bailout of Greece, said April 22 that “fiscal fragilities” pose the biggest threat to the worldwide recovery.

Earnings for S&P 500 energy companies will increase 54 percent in the next 12 months, according to the mean estimate of analysts surveyed by Bloomberg. The gain, the second-largest forecast increase in the index behind banks, would mark the industry’s biggest advance in four years and pushes valuations based on expected profits to the lowest level in the S&P 500.

“You’re likely to see more resilient demand than has historically been there, and you know that oil is probably going to be in shortage for some time,” said Philip Dow, the Minneapolis-based director of equity strategy at RBC Wealth Management, which oversees $164 billion. “The single biggest message in this is that you definitely want to own oil companies.”

Beating Estimates

Energy producers beat estimates by an average 9.6 percent in the first quarter and by 4.5 percent in the fourth. The gains came after the 78 percent surge in crude prices last year helped offset low demand for the refining businesses of integrated companies, said Pavel Molchanov, the third-most-accurate analyst on New York-based Hess Corp., according to Bloomberg rankings based on stock performance.

“Because we’re still just in the early stages of recovery after the recession, demand for gasoline and diesel’s still relatively low, and so refining margins are proportionately low,” said Molchanov, with Raymond James & Associates in Houston. “Once petroleum demands move up over the next year or two with the economy, then downstream earnings would increase. As oil prices continue to move up, then upstream earnings increase.”

Bears Return

While U.S. gross domestic product recovered in the second half of last year from four straight quarters of declines, some investors were speculating last week that the rebound was over. The Dow Jones Industrial Average lost 628 points, the most since the bull market began in March 2009, on concern sovereign debt defaults might spur bank losses in Europe.

Economic contraction may end the rally in oil prices, which have more than doubled since December 2008. While total U.S. liquid fuels consumption may climb this year, it’s still below its peak from the last decade, according to the Washington-based Energy Information Administration.

“You have the uncertainty about where oil prices are headed,” said Nick Sargen, chief investment officer at Fort Washington Investment Advisors in Cincinnati, which oversees more than $30 billion. “It’s a very uneven recovery.”

Oil Spill

Since BP Plc’s oil spill last month in the Gulf of Mexico, crude dropped 10 percent to $75.11 a barrel, with related U.S. companies sliding 8.7 percent as a group. The U.S. Interior Department halted offshore drilling permits last week until at least the end of May and delayed public meetings on expanding drilling as the oil slick began to come ashore in Louisiana.

For integrated energy companies such as Irving, Texas-based Exxon Mobil and Chevron Corp. in San Ramon, California, that explore and produce oil, gas and coal, the forecast rise in crude’s price may boost profits less because the commodity is directly related to a smaller percentage of revenue, Molchanov said.

Energy suppliers in the S&P 500 rallied 242 percent starting in October 2002 to lead a five-year advance in which the measure doubled, data compiled by Bloomberg show. They’ve climbed 33 percent since March 9, 2009, the third-smallest gain among 10 industries as the S&P 500 staged the biggest advance since the 1930s.

Oil prices and the S&P 500 have increasingly moved together since September 2008, after New York-based Lehman Brothers Holdings Inc. filed for the world’s biggest bankruptcy, deepening the global financial crisis.

Correlation Math

The so-called correlation coefficient between New York crude and the stock index has increased to 0.66, data compiled by Bloomberg show. That matches the level reached in September, which showed the strongest link since at least 1986. The S&P 500 has risen 64 percent to 1,110.88 since sinking to a 12-year low in March 2009, while oil jumped 60 percent in the same period.

Crude is projected to climb 13 percent to $84.71 a barrel by the end of the year and reach $86.22 by June 30, 2011, according to the average weighted estimate of 31 energy analysts surveyed by Bloomberg. Equity strategists at 13 firms from New York-based Goldman Sachs Group Inc. to JPMorgan Chase & Co. and Citigroup Inc. foresee a 14 percent advance to 1,268 for the S&P 500 through Dec. 31, according to the average forecast in a Bloomberg survey.

“As the global economy improves, demand for oil should increase,” said Eric Marshall, who helps oversee $1 billion as research director of Dallas-based Hodges Capital Management Inc. “We think the long-term prospects of higher oil consumption are still intact.”

Driller Ratio

Oil and gas drillers had a higher multiple than the S&P 500 for the second half of 1994 after a Federal Reserve interest- rate increase ended a three-year rally in stocks. The index advanced 26 percent for the next four quarters into 1995.

While investors called the end of the Internet bubble, the S&P 500 rose 17 percent into 2000. The collapse of technology stocks and accounting scandals at Enron Corp. and WorldCom Inc. drove the S&P 500 to a five-year low in 2002 before surging 26 percent into 2003.

“Obviously we’ve had some setbacks in the past couple of weeks with the sovereign debt crisis in Europe and oil spills,” said John Carey, Boston-based money-manager at Pioneer Investment Management, which oversees about $230 billion. “There are things that can happen to throw everything off course at least short-term, but I think basically the world economic picture is pretty positive. Once growth gets under way it has pretty strong momentum. It’s hard to turn it around.”

To contact the reporters on this story: Whitney Kisling in New York at wkisling@bloomberg.net.

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