JPMorgan stated in a Thursday note that the sharp outperformance of energy stocks in this year's financial year is likely to continue.
The bank named the energy sector one of its favorite sectors and stated that it offered a favorable risk-reward ratio.
These are three reasons JPMorgan advises its clients to invest energy stocks.
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Investors who missed this year's best performing sector can still get some exposure. JPMorgan stated that energy stocks are still available for those who have not yet gotten their hands on them in a note they sent on Thursday.
The Energy sector has seen a nearly 50% increase in year-to-date, almost triple the 17% gain recorded by the S&P 500 over the same period. The bank said that there is still time for energy stocks and the wider market to catch up if you look at the longer term. The energy sector has been trailing the wider market by 183% since 2014.
JPMorgan expects energy stocks to continue their gains as a supply crunch drives oil, natural gas and coal prices through new heights. JPMorgan expects oil to rise to $130 per barrel.
JPMorgan stated that the energy sector has a favorable risk-reward profile for investors due to three main reasons: lower valuations, improved fundamentals and increased capital returns.
Analysts noted that energy stocks now account for only 3% of the S&P 500, a drop of 20% from a previous point. This leaves a lot of room for the sector to grow its value in an environment where favorable economics prevail over oil companies.
JPMorgan stated that energy recovery will be faster than other asset classes like commercial real estate in the 1990s, dot.com in the 2000s and financials/housing in the 2010s.
According to the bank, investors who want the best upside potential in this sector should invest in small-cap energy stocks. Because they are more sensitive to rising oil prices and are in balance sheet recovery, small-cap energy stocks could be targets for mergers as larger peers seek to increase their reserves.
Many of the risk factors that investors have been afraid of in the energy sector over the last few years, such as regulations and the rise of ESG investment and an increase in electric cars, can actually be catalysts for buybacks or dividends.
JPMorgan stated that these factors "help bring much-needed discipline to the sector with an emphasis on reducing debt, returning excess shareholder capital, rather than higher production and market share."
