Energy stocks moving higher is the "pain trade" for 2022, according to Bank of America.- There's additional upside ahead for the sector, even though its 38% year-to-date rally is "long in the tooth," BofA said.
- These are three reasons why BofA sees additional upside in
energy stocks later this year.
Energy stocks have already rallied 38% year-to-date, but Bank of America sees additional upside ahead as the sector represents 2022's "pain trade."
A pain trade is the directional trade of a particular asset that will inflict the most harm on a majority of market participants. In this case, BofA calls the energy sector this year's pain trade because few investors have adequate exposure to the sector. But as they slowly buy in, it could help sustain further inflows.
Oil and gas prices have surged in 2022 as COVID-19 recedes and travel demand heats up while supply shrinks due to Russia's invasion of Ukraine. "It may be getting long in the tooth, but we see three key tailwinds for the sector," BofA said.
1. 'Energy Security'
Following Russia's invasion of Ukraine and the ensuing sanctions against Moscow, investors and policy makers have woken up to the fact that having ample domestic energy production and supplies are key to economic and national security. That should help renew an influx of investments into the sector following the end of the American shale boom. "Energy security is oxygen to the economy," BofA said.
2. 'Energy just doubled in the benchmark'
In 2020, the energy sector's allocation in the S&P 500 fell to just 1.9%. Its allocation has since doubled to about 3.9%, but that's still well below its 10% weighting in 2010. "Investors are still 26% underweight the sector... and now owning energy would have detracted over one percentage point of alpha in the first quarter," BofA said.
3. 'Cash'
"Our economists forecast the cash yield rising to 3.25% to 3.50% by mid next year, which will make cash the most valuable in about 15 years. Energy companies are expected to generate inflation-proof free cash flow yield of 15% this year, a record level in our data history since 1986," BofA said.
"Despite a 38% rally in Energy year-to-date, its valuation is still attractive given the backdrop of high inflation and a rising cash yield," BofA concluded.
BofA isn't the only bank with a bullish outlook on oil, as JPMorgan outlined in a Wednesday note why commodities could surge another 40% from current levels.