Q4 2024 Capital Markets Perspective [PODCAST]
Our experts lay out their expectations for the fourth quarter and the months beyond.
Our experts lay out their expectations for the fourth quarter and the months beyond.
10/07/2024
MARKET UPDATE
05/28/2024
After a strong first quarter of 2024, what’s ahead for this important market sector?
In the first quarter, energy was the top performing sector of the S&P 500® Index. Coming up, we tell you why investors are watching energy companies closely and lay out expectations for the sector for the rest of the year.
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From Thrivent Asset Management, welcome to Advisor’s Market360™, a podcast for you, the driven financial advisor.
The energy sector offered impressive performance in the first quarter of 2024. But, can it continue to be the leading sector of the S&P 500 index going forward? That’s just one of the questions we put to John Groton Jr., CFA, Thrivent’s director of equity research program administration and senior equity research analyst.
Later in the episode, we will also hear from Kurt Lauber, CFA, senior portfolio manager of Thrivent Large Cap Value Fund. Lauber will discuss the role of the energy sector in the Fund and he will also give us some insights into how his team of analysts evaluate investment opportunities.
Let’s get to it…
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To start, we wanted to get an understanding of why the energy sector performed so well in the first quarter of 2024. Groton explains the influences that continue to drive that performance.
(Groton) “When talking about the energy sector, we start with commodity prices as an influence on sector performance. Oil prices are up year to date, but the giant energy companies that make up most of the sector market cap also produce natural gas and chemicals, both of which have not done well recently. So, it's not just about oil prices.”
Beyond oil prices, we wanted to know what information Groton seeks out to better understand the energy sector and the broader economy.
(Groton) “A closely watched dataset to gauge the world economy is the manufacturing purchasing managers index, or PMI. The manufacturing PMI summarizes economic trends, highlighting when market conditions are expanding, holding steady or contracting as viewed by purchasing managers around the world. China flipped from contraction to expansion during the first quarter, boosting cyclical sectors, energy included. The global PMI was positive for the first time since August 2022.
“Lastly and related is a change in perception that inflation will be with us longer than previously thought. Higher oil prices are partially a cause of this change, but inflation is generally good for commodity sectors.”
We all know that performance is never guaranteed. And that holds true with the energy sector. We wanted to get Groton’s take on the risks that could affect the sector in the near future.
(Groton) “The biggest risk for oil and gas, both the commodities and the stocks, is consumer health. Demand is harder to forecast than supply. If unemployment bumps up, if consumers continue to be pinched by inflation and cut back on flying and driving, if global conflicts worsen, all are bad for demand. Commodity sectors do okay with inflation; they do not with poor demand.”
Looking at risk factors in the longer-term, Groton had this to say:
(Groton) “Long term, a much-discussed risk is the transition away from fossil fuels. We have a contrarian viewpoint on the issue as supply appears to be adjusting faster than demand, which may mean higher prices in the future. Looking at renewable energy, risks facing the industry for the rest of the year is harder to answer than the risks over longer time periods.
“One important risk is most development still needs government subsidy support, and government can change its mind. Our election in November will matter. But I don't just mean in the US. Europe has backed off some of its more ambitious plans, as placing renewables goals in a spreadsheet is easy, but implementing for real and doing so economically is hard.
“If renewables growth slows, either from less government financial support or lack of necessary commodities, who gets to use the limited green power? Is it homes? EVs? Data centers?”
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As Groton mentioned, the energy sector encompasses more than oil and gas. It also includes a wide range of renewable energy sources, such as wind and solar. Which led to a discussion of not only green energy but the industries that are supported by its development and those that use the energy produced. Putting aside the environmental impact, we wanted to understand these ancillary industries from an investment perspective. Here’s Groton:
(Groton) “Electric vehicles and most renewable sectors, despite tremendous growth, have been difficult areas for investors. They haven't been strong at all. All stocks go in fits and starts, but wind turbine makers, solar panel manufacturing and hydrogen fuel cell companies have been poor investments. Manufacturing over capacity is the main reason.”
We wanted to go a little deeper on electric vehicles, or EVs. Earlier this year, Tesla was a part of the “Magnificent Seven,” a group of tech-centric, mega-cap growth names that have led the equity market in recent years. However, Tesla made headlines earlier this year for not keeping up with the rest of the pack. What's the story behind Tesla and EVs in general? Here are Groton’s thoughts:
(Groton) “Tesla absorbs the oxygen in the room here, but the story is really in China and Europe that are far ahead of the US regarding EV penetration. The largest EV manufacturer isn't Tesla. It's China's BYD. Too much capacity is an issue here too, as BYD stock is unchanged versus three years ago.
“Often with new technologies, the hype curve is bigger than the reality curve, but realistic growth can happen, just maybe not as fast as we all used to think.”
Speaking of China, we wanted get Groton’s insights about the global influences on the energy sector for fossil fuels.
(Groton) “I first started researching the sector in the early 1990s, and for 20 years up to that point and 20 years after, we worried about our dependence on foreign and oil. That's no longer true. Combining oil and natural gas and coal, we are an energy exporter. So, the global market matters.”
We also wanted to hear about other international factors that can affect energy markets.
(Groton) “Geopolitics for sure. We've had a tight range in which oil has traded, the exception being the spring of 2022 when the Russia/Ukraine conflict started, and oil prices spiked. Recently, each country has attacked the other's energy infrastructure and we have another conflict in the middle of the most important production region in the world, yet we still have average prices.
“Natural gas is less discussed but is nearly as important geopolitically. Europe depends on Russian gas. At least it did prior to 2022. Markets quickly adjusted, supplying liquefied natural gas from the US and elsewhere. It's really interesting; natural gas is chilled to -260 degrees Fahrenheit and shipped in what is really a giant thermos bottle across the ocean. Natural gas used to be a regional market but is now global.”
Groton also had some thoughts on the global renewable energy market.
(Groton) “For renewable energy as a global topic, equipment supply is what matters. The power itself is regional. It does not cross oceans. But it's getting more complicated logistically and politically. COVID supply chain problems are recent memories for renewable project developers.
“Also, we’d prefer to not rely on China for solar panels, for example. Reshoring is a theme, but by definition, moving away from economically optimal supply chains for those reasons makes everything more expensive.”
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Switching gears a bit, we turned to Kurt Lauber, CFA to get a portfolio manager’s perspective on the energy sector and to learn a little more about Thrivent Large Cap Value Fund. Specifically, the analysts that are assigned to the Fund.
(Lauber) “Here at Thrivent, we have a bunch of experienced large-cap analysts and small-cap analysts. What we ask of them is to have their own investment process. They have to understand how they make money in their sector. If it's a cyclical sector like energy and materials, it'll be a cyclical process, that is, buy when things are at the worst, when supply is much greater than demand, profits are at the lowest, we know they'll rationalize that supply and they may improve profits. But you have to go in and buy when things are at the worst. And of course, sell when things are looking excellent.”
With a general understanding of how the analysts evaluate investments, we wanted to dig a little deeper on the energy sector. Here’s Lauber:
(Lauber) “Looking at energy today, we came into this year at an overweight of energy in our portfolio. And the reason is twofold. At the beginning of the year, energy prices were at a low, right? We came into the year with the fear going into the end of last year—hey, there could be a recession, demand was weak, commodity prices were low. And we took advantage of that to go to an overweight.”
Today, energy is a very important sector that attracts a lot of investment. That wasn’t always the case. We asked Lauber when the tide turned for the energy sector.
(Lauber) “So, if you look at energy on a return basis, we go back to 2015 when this industry absolutely blew up, right? The fracking was new. Production in the U.S. was a low-cost area. It attracted so much capital and all the E and P—exploration and production—companies, as well as Exxon and Chevron, were just drilling like crazy. They just all cared about production, and it massively blew up.
“And all of a sudden, the energy sector got ‘return on invested capital religion.’ That's what attracted us to it. Now, will they sustain that? Will they stay committed? That's to play out over time. But right now, when you look at the valuations—just to take an example, Exxon, it's trading in a similar multiple as it did in 2018, 2019. But the returns going on to next cycle should be much better as the industry is really focused on returns.”
While we are mostly talking about the energy sector, we also wanted to get Lauber’s take on why Thrivent Large Cap Value Fund might be a good option for investors. While, admittedly, growth stocks have been ahead of value stocks for more than a decade, diversification has the potential to play a role in risk management. Lauber was proud to share that Thrivent Large Cap Value Fund has performed well in annualized returns over the 5-, 10- and 20-year time periods, outperforming nearly 80% of the Fund’s competitors in its Morningstar peer group. For context, the comparisons that Lauber makes are based on the Fund’s Morningstar peer group.
We also wanted a little clarification on what an information ratio is.
(Lauber) “What an information ratio is, it's really taking your returns over the risk you were taking on. So, we took on very low risk relative to the return. So, it's really an indication of stock picking. We're stock pickers. We try to be sector neutral. We'll go a little over- or underweight in any sector, but we really do it from the bottom-up stock picking. And we proved over time that we've been able to do this.
“And now that doesn't give—we can't tell you what the future is going to be, or if we can do this in the future. But our history has shown that we're good stock pickers. We try to do things with stock selection. We try to do everything bottom-up, and we try to stay sector neutral. And then we will be over- or underweight a sector if we feel like materials or energy is an interesting place to be because of the return/value trade off.”
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If you go back to economics 101, you will recall that prices are driven by the law of supply and demand. So far, we have mostly addressed the supply side of the energy sector, but what is driving demand? One area where energy demand is increasing rapidly is in its use to power artificial intelligence. We asked Groton about this:
(Groton) “Artificial intelligence, or AI, is of interest to energy sector investors and has an influence on the natural gas industry because AI needs computing power. Computing power needs electrical power. Electrical power requirements cannot be met only with renewables leading to natural gas as the baseload power source. In 2023, we saw increases in natural gas demand as a source of power for AI companies. It's an influence we are keeping a close eye on.”
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As we look at the prospects for the energy sector going forward and its role in Thrivent Large Cap Value Fund, Lauber anticipates staying overweight on energy companies. And while Groton continues to the energy sector, he doesn’t anticipate that it will continue to perform like it did in the first quarter.
(Groton) “We do not think energy will be a big outperformer for the rest of the year. Oil prices are up in the mid-teens year to date, but part of that is prices were at the low end of norms at the end of December. It's just a quirk of timing. For the past three years, other than a couple months in early 2022, oil has not been volatile, locked in a range between $70 and $90 per barrel. Today we are near the middle of that range and do not think we have a sharp break in either direction.”
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Once again, we would like to thank John Groton and Kurt Lauber for their insights. What did you think of this episode? Email us at podcast@thriventfunds.com with your feedback or questions for our experts. Want more episodes of Advisors Market360™ and other market and investing insights? Visit us at thriventfunds.com, where you can learn how we can partner with you, the driven financial advisor. Bye for now.
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