The best-performing sector in 2022 is not finished crushing it, says Citi, offering three stocks to buy

“We see market rotation into energy equities as having further to run, even though names in our U.S. coverage already sit at all-time highs,” a team of analysts led by Alastair R Syme told clients in a fresh note. “History says energy equities usually perform well in an earnings recession, Citi’s base-case for 2023.”

That bullish view comes after energy roared back into the spotlight on Monday, providing at least some distraction from the equity market’s endless bear-bottom debates.

Hitting a level not seen since January, crude tumbled to $75.08 a barrel on rumors OPEC was mulling a production increase. A swift denial from Saudi Arabia pushed prices back near $80, where they are sitting for Tuesday.

Oil’s tumble also briefly knocked the year’s best performing energy sector, via the SPDR Energy Select Sector ETF 
XLE,
+3.13%,
to four-month lows before it recouped some losses. The ETF is still up a whopping 62% this year, beating all comers.

To be sure, the path for the commodity backing those stocks is a murky one, with crude struggling to make new highs since a summer run to over $109 a barrel.

But Citi’s Syme and the team say they can look past the fundamental oil picture, for now.

“Our view on the sector comes despite a view that commodity-price inflation, the story of 2021 and early 2022, is now largely behind us. We expect oil markets to begin to see inventory builds from next spring. Gas remains uncertain during the winter, but generally, we think the global energy system is adapting to accommodate Europe’s crisis,” said Citi.

As for Citi’s view that energy equities perform well in a recession, they admit that the highest returns usually come in the first year of the market rotation. However, Syme said outperformance will typically carry on until the earnings cycle turns. They lifted price targets on several energy names and upgraded BP
BP,
+5.31%

BP,
+1.63%
to buy.

“Without commodity price-inflation, growth and asset duration becomes a more important driver of relative equity performance, in our view,” said the analysts. Their three top picks in the energy sector are buy-rated BP
BP,
+5.31%
BP,
+1.63%
— upgraded by Citi on Tuesday — Spain’s Repsol
REP,
+1.89%

REPYY,
+6.35%
and ConocoPhillips
COP,
+3.58%.

Citi backed up its BP upgrade with some advantages it sees: valuations that put it over European peers; a lack of chemicals exposure, which they see as a key headwind for global peers in 2023; and the potential to differentiate around underlying growth, driven by upstream and marketing.

Citi lifted its target price for BP to 540 pence from 440 pence a share, while ConocoPhillips’ target was lifted 21% to $160 a share. Among neutral-rated names, Chevron’s
CVX,
+2.57%
target was lifted 16% to $180, Exxon’s
XOM,
+2.89%
was lifted 12% to $110, Shell’s
SHEL,
+0.97%

SHEL,
+3.89%
was boosted 9% to 2360 pence and Eni’s
ENI,
+1.64%
was lifted 16% to €14. Repsol’s targets were lifted 3% to €17..

Note, Citi’s economists do see the global economy continuing to lose steam with the U.S. tipping into recession by the third quarter of 2023 and Europe already there. The OECD also came out with its forecasts and not surprisingly, they were gloomy.

And they’ve got caveats for investors to consider when it comes to this dazzling sector. They say relative performance of energy stocks, while still positive, will start to diminish given that stocks have seen such a big run-up in 2022. Also, don’t get greedy, or “hold on too long,” said Syme and the team, who warned that when the demand-side collapse starts to really kick in, sector performance will start to suffer.

The markets

Stocks
DJIA,
+1.18%

SPX,
+1.36%

COMP,
+1.36%
are mixed, with bond yields
TMUBMUSD10Y,
3.759%

TMUBMUSD02Y,
4.537%
slipping and the dollar
DXY,
-0.04%
pulls back. Oil prices
CL.1,
+0.51%

BRN00,
+0.55%
are higher after Monday’s tumultuous session. Gold
GC00,
-0.22%
and silver
SI00,
+0.34%
prices are firmer, and bitcoin
BTCUSD,
+2.32%
is slightly higher at $15,776.

The buzz

Saudi Arabia delivered the first World Cup upset, beating Argentina 2-1.

Dollar Tree
DLTR,
-7.79%
shares are down after the retailer beat forecasts, but delivered downbeat guidance. Dell
DELL,
+6.77%
is dropping after the PC maker’s weak forecast overshadowed an earnings beat. Zoom
ZM,
-3.87%
also delivered upbeat results, but shares are down on disappointing guidance. HP
HPQ,
+0.75%
will report after the close.

Baidu shares
BIDU,
+0.55%
are rising after the Chinese internet giant delivered forecast-beating revenue. 

Lordstown Motors 
RIDE,
-5.00%
and Nikola 
NKLA,
-9.09%
are among several stocks that Goldman warns are burning through cash and may need to raise capital soon. The bank also points out that Microsoft has now overtaken Amazon as the stock with the most long hedge-fund positions.

Days after China President Xi Jinping spoke of redistributing wealth, JD.com
9618,
+3.34%

JD,
-1.79%
said it would cut executive salaries by 10% to 15% to boost benefits for lower-level employees.

A speech from Kansas City Fed President Esther George is the only economic item of note for Tuesday.

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