2008 Sector Outlook: Energy

Here's the third in a series examining the outlook for five sectors. S&P analysts' fundamental outlook for energy is neutral

From Standard & Poor's Equity Research

How do key S&P 500 sectors stack up for 2008? Here is the third in a series examining the outlook for five S&P sectors: the four with marketweight recommendations that have the largest market cap weightings in the Standard & Poor's 500-stock index—and the one sector with an overweight recommendation. A selection of five of S&P's top-ranked stocks in each sector is also featured. Be sure to check back in the days to follow for more sectors—and more stock picks.

More information about S&P equity research can be found at http://outlook.standardandpoors.com.


Sector Recommendation: MARKETWEIGHT

S&P 500 Market Cap Weighting: 12.1%

S&P recommends marketweighting the S&P 500 Energy sector. Year to date through Nov. 23, the S&P Energy index, which represented 12.1% of the S&P 500 index, was up 23.4%, compared to a 1.6% gain for the S&P 500. There are seven subindustry indexes in this sector, with Integrated Oil & Gas by far the largest at 61% of the sector's market value.

S&P equity analysts have a neutral fundamental outlook for the sector, reflecting an expected near-term decline in oil prices from record levels, plus below-market earnings-per-share growth estimates in 2008. S&P projects prices for the benchmark grade of West Texas Intermediate (WTI) crude oil will remain elevated, however, averaging $84.67 per barrel in 2008. S&P analysts forecast that the sector's EPS will rise 5% in 2008, vs. 15% for the broader market.

However, we believe the sector's unimpressive EPS outlook is offset by the second-lowest valuation in the S&P 500. Its price-to-earnings ratio on estimated 2008 earnings of 11.9 times is well below the 13.9 times p-e of the 500. Its p-e to projected five-year EPS growth rate (PEG) ratio of 1 times is below the broader market's 1.1 times.

Our technical opinion on the S&P 500 Energy sector is negative. The index has broken to the downside, and we think the sector could see a 10% to 15% correction over the next couple of months. This would bring energy back down to the lows of August. On a relative strength basis, energy has been in an uptrend since the beginning of the year, but may be working on a double top vs. the S&P 500.

Overall, we recommend marketweighting the energy sector, as we expect a decline in oil prices in the not-too-distant future, as well as a narrowing of refining margins and below-market 2008 EPS growth for the group. Also, we believe the technical outlook for WTI crude oil has deteriorated and think a sharp correction is possible over the coming months.

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