3 Reasons Why Energy Will Be The Best Performing Sector This Summer

Includes: AAPL, HAL, OIH, SLB, SPY
by: The Independent Investor

Wow, what a boring market. With the now nearly six month rally slowing, most of the best-performing sectors in the market, like the financials and big-cap tech, have moved only modest amounts in the last month. While stocks like Apple (AAPL) continue to move higher, the S&P 500 has moved very little over the last month.

Equity markets continue to move higher worldwide on modestly improving economic data, and as the month nears a close, it is likely that we will begin to see traditionally seasonally stronger sectors perform better as growth continues to pick up. The sector that I think will perform the best is energy, and here's why.

Energy stocks have moved up with the overall market, but major oil stocks in the oil service sector have lagged most of the broader indexes by a fairly wide margin over the last several months, despite WTI and Brent prices being near their historical highs. Let's look at a comparison between the OIH (OIH) exchange traded fund and the S&P 500's tracking exchange traded fund (SPY).

Chart from Thestreet.com

Also, while energy prices remain high, they are likely to move higher in the summer months for several reasons.

First, while growth remains tepid, production levels from the countries with the most desired grades of sweet crude like Libya are still producing at significantly below average levels. Countries like Saudi Arabia have pledged to step up production, but they lack the right grades of oil, their economies require high prices because of their social needs now today as well.

Political instability in the Middle East also remains at high levels. While the Iraq and Libyan wars have ended, Syria remains in turmoil, violence in Egypt remains high, and Iran continues to pursue nuclear weapons.

Finally, the summer has usually been the peak demand period for oil since U.S. drivers tend to travel the most during these warmer months. The weather has also been historically warm this year already, with temperatures the second hottest on record already in major cities like Chicago. China may be the biggest importer of oil today, but the U.S. still comprises nearly 20% of worldwide demand for oil.

Still, since oil prices are high today, it is worth asking what the catalyst will be to get these stocks going?

Here I think several new catalysts will send the energy sector higher in the summer.

First, as I discussed at length in previous articles, I think BP's (NYSE:BP) recent civil settlement with most gulf plaintiffs paves the way for a settlement with the Gulf States and Federal government in the next couple months. While BP's issues are company specific, permits in the gulf have been approved at historically low rates over the last two years, and a final settlement should clarify important legal precedents for the industry.

Second, while Obama looks increasingly likely to get re-elected as his approval numbers are now over 50%, Republicans are likely to retain the House.

With a divided government the likely outcome of the 2012 election, energy should be an issue where both sides can compromise. Obama obviously favors renewable energy, with gas prices near their historical highs, the president will likely want to take some important actions that at least appear to be addressing the issue today. The Senate also recently rejected Obama's efforts to curb tax breaks for big oil as well.

Even though the elections won't occur until November, Obama has already begun to change his tune a little big by specifically mentioning fossil fuels like natural gas in his presidential addresses that now outline the all of the above approach.

Third, and finally, as I talked about in my previous article, I think we will likely see a rotation of capital going into the summer season. While big-cap tech and the financials have led the rally so far, energy stocks have lagged. With energy being a traditionally strong summer sector and many major oil service stocks like Schlumberger (SLB) and Halliburton (HAL) trading at single digit PEs, I think wealth managers will look to rebalance their portfolios by reallocating capital into some of the sectors in the market that have underperformed so far.

To conclude, while past results are important to consider in considering future performance, the future doesn't always mimic the past. Tech and financial stocks have led the rally so far, but the market has not moved up at the same rapid pace over the last month.

With the first quarter ending and valuation in the energy sector at the low end of their historic range going into the summer, I think the energy sector is the best place in the market to allocate new capital today.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.