With the gains in September, energy is once again the best-performing S&P 500 sector for the year, though it did finish the third quarter in the red due to some weakness over the summer as the delta variant temporarily halted demand for petroleum products.
Nonetheless, the sector is expected to grow by 38% by 2021. The next best performers are financials and real estate, which are up 27% and 22%, respectively.
The rise in oil and natural gas prices has boosted the value of energy stocks.
Demand is increasing as people get back on the road and economies around the world reopen, while supply is remaining stable. As winter approaches, stockpiles are lower than usual, particularly in Europe, where an energy crisis has sent power prices skyrocketing to all-time highs.
“We remain optimistic about the broader oil sector, with memories of the 2003 underinvestment cycle resurfacing,” said Bank of America analysts.
Analysts combed through the energy sector for names that at least 70% of analysts say to buy to find Wall Street’s top picks for the fourth quarter. We focused on stocks with at least a 10% upside based on average price targets from that list.
“Acquiring Shell’s Permian business is a positive catalyst for COP because it adds to free cash flow earmarked for shareholder return and provides flexibility for improvements such as economies of scale,” Atlantic Equities said in a note to clients following the purchase.
Shares of the energy company are up roughly 72 percent this year, and analysts expect the stock to rise another 14 percent.
This year, Diamondback Energy stock has nearly doubled, and analysts predict another 20% gain in the coming months.
In September, the company announced plans to accelerate its capital return program, stating that it will return 50% of its free cash flow to stockholders starting in the fourth quarter, rather than in 2022, as previously planned. Diamondback Energy also announced a $2 billion share repurchase program.
“We believe the accelerated return program, in conjunction with the share repurchase program, highlights Diamondback’s strong operational and financial performance, as well as its commitment to capital discipline and shareholder returns,” Stifel said in a client note following the announcement.
“The company’s cost leadership, balance sheet, minerals, and midstream ownership are just a few of the reasons it is well-positioned to outperform as activity grows,” the firm added.
Marathon Petroleum is also on the list, with nearly 80% of analysts recommending that investors buy the stock. Other companies on the list include Valero and Baker Hughes.
According to Jefferies analysts, the power outage has already spread to 20 provinces and comes just months before the highly anticipated Winter Olympic Games in Beijing in February 2022.
“Not only is supply being impacted, but end demand, particularly in manufacturing-related sectors,” they wrote in a note.
The current power shortage in China is the result of increased regulatory pressure to reduce energy consumption and intensity. It comes after China President Xi Jinping announced in September that the country’s goal is to achieve peak carbon emissions by 2030 and carbon neutrality by 2060.
China’s power shortage has cast doubt on the country’s economic prospects, with several economists downgrading their forecasts for 2021 GDP growth, citing energy constraints as one of the headwinds.
Following an examination of 11 commodities, the analysts identified cement, poly, and lithium as the commodities “best positioned to benefit” from the energy crisis.
According to Jefferies analysts, materials companies are the “most sensitive” to changes in average selling prices, and a 1% change in ASP is equivalent to a 1.5% to 7% change in earnings.
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“Cement and lithium have the largest swing to earnings because ASPs have increased by 27 percent and 50 percent in the last month, respectively, and are the biggest winners among power shortages,” the analysts said.
Cement inventories have also fallen to a “historical low,” while supplies for leading polysilicon are running low, with producers having less than three days of inventory, according to a Tuesday report.
Stocks to purchase
According to Jefferies, now is the time to invest in cement producer China National Building Material, polysilicon manufacturer DAQO New Energy, and lithium manufacturer Ganfeng Lithium, as they will benefit from this trend.
China’s efforts to reduce emissions, combined with a shortage of coal supplies, have resulted in nationwide power outages. According to Reuters, this has disrupted production at factories that supply Apple and Tesla.
Due to the additional headwinds posed by the power shortage, firms such as Goldman Sachs, Nomura, S&P Global Ratings, and Fitch have reduced their China economic growth forecasts.
Airline stock comeback
Southwest Airlines’ stock rose nearly 2% in premarket trading after the Wall Street firm upgraded it from neutral to overweight.
Southwest has recovered from the coronavirus-induced sell-off in 2020. While the stock is up about 10% this year, the airline industry is still working its way back to pre-pandemic levels. JPMorgan does not believe the airline sector is as long-term investible as it was prior to COVID-19, and believes airline stocks are best considered trading stocks for the time being.
“Spend has increased, RTO plans appear to be stable, COVID-19 data is largely pointing in the right direction, and US borders are set to open (with caveats) in time to save the all-important 4Q holidays,” Baker added.
JPMorgan forecasts a 1.5 percent increase in revenue and a 1.7 percent increase in capacity for Southwest in 2023, with a healthy 2 percent decrease in fuel costs.
“Given the lower fuel cost ($2.00 estimate vs. 2019′s $2.08 actual), these minor changes result in a 4 point increase in operating margin and $4.68 of earnings (relative to the $4.79 consensus, with a range of $4.00 to $6.40),” Baker said.
Frontier Group Holdings was upgraded to overweight from neutral by JPMorgan on Friday, while Spirit Airlines was downgraded to neutral from overweight. Alaska Airlines, Delta, and JetBlue have all received buy ratings from the firm.
Top UK stocks
Consumers in the United Kingdom saved a lot of money during lockdowns because social restrictions limited their ability to shop, socialize, and go on vacation. Experts predict that spending will increase in the near future.
“Consumer spending, fueled by unusually high levels of savings,” said Dean Turner, economist at UBS, in a note on September 27.
“Add to that retailers restocking and manufacturers rebuilding inventories—all against a backdrop of loose monetary and fiscal policy—and it’s not difficult to envision above-trend growth for the foreseeable future.”
The head of research at British investment bank Peel Hunt, Charles Hunt, identified a number of opportunities to capitalize on this trend.
“There are significant cash balances in the United Kingdom. People will be much more eager to buy products this Christmas,” he predicted, adding that companies with a strong online presence and delivery options will benefit as a result. His favorite retailers are Next, Dfs, and Boohoo.
Hunt also noted that U.K. shoppers continue to want to spend money on their homes, a trend that began during the pandemic and is likely to continue as many workers continue to work from home to some extent. He mentioned Howdens, a kitchen developer in the United Kingdom, as a stock to watch.
“A lot more people will want to go on vacation,” Hunt predicted, naming low-cost airline Jet2 as a potential winner in the space.
The travel industry has benefited greatly from recent government announcements regarding looser travel regulations. The United States, for example, announced last month that it would be open to fully vaccinated foreign visitors without the need for quarantine upon arrival.
‘Peers are in disarray.’
According to Simon Young, portfolio manager at AXA Investment Managers, the pandemic has provided a unique opportunity for a number of British firms.
“Some companies have taken advantage of disarray among peers to increase their competitive positions,” he wrote in a note published on September 21.
“We have taken advantage of the opportunity to establish stakes in great companies that have been hard hit by the pandemic but that we believe will emerge fitter and even more competitive.”
Young’s top stock picks include the bakery chain Greggs, the food service company Compass Group, and the insurance firm Admiral Insurance.
These selections highlight a trend that many investors have identified as social restrictions are lifted — specifically, the reopening of the economy.
Turner of UBS agreed that a number of stocks exposed to this reopening theme have the potential for a recovery.
“The ‘reopening trade’ has been harmed in recent months by concerns about the delta variant, but we expect a catch-up in the months ahead as vaccination rates increase, booster shots are administered, and mobility restrictions are lifted more permanently,” he added.
Stocks fighting volatility
Several trends dominated the third quarter, including supply chain disruptions, political squabbling in Washington, and the Federal Reserve’s announcement that it would soon begin reducing asset purchases.
Lesser-known names in health care, technology, and finance dominate the top 20. The only sector that finished higher in September was energy, which made a minor appearance.
As Covid-19 vaccines continued to be rolled out to more people and talk of a Covid booster shot evolved, Moderna generated the highest return in the S&P for the third quarter, around 60%. The vaccine maker’s stock soared after it announced plans to test a Covid-flu vaccine combination.
Moderna has increased by a whopping 268 percent this year.
Paycom, on the other hand, is only up about 8% for the year. Nonetheless, as people began reentering the labor force, the payroll services company generated the second-largest returns for the quarter, about 36 percent. According to Oppenheimer’s Brian Schwartz, government stimulus aimed at mid-market and small businesses aided the firm as well.
Paycom also debuted a self-service payroll product this quarter, which investors are excited about because of its potential to expand beyond payroll and other employment services markets, according to Schwartz.
Monolithic Power Systems, a high-performance analog semiconductor company, increased by 29 percent in the third quarter and by about 32 percent year to date.
Quanta Services, a contracting services firm, increased by about 25% for the quarter.
Oil prices fell in the middle of the quarter but have since risen. While many of the top performers in the third quarter had a down month or only made minor gains in September, Quanta is up more than 11% for the month.
The S&P 500 is expected to end the third quarter slightly higher, with gains muted by a poor showing in September.
The S&P 500 index is nearly 5% lower than its peak, which was set on September 2.
Analysts identified stocks with at least 70% of analysts recommending a buy to find the names Wall Street believes will lead the market higher in the coming quarter. We then identified the top ten stocks in that pool based on consensus 12-month price target upside.
The names on our screen are heavily skewed toward the economic recovery, with many industrial and financial names. There are also a few defensive stocks on the list, such as utilities and health care names.
News Corp, the parent company of The Wall Street Journal-publisher Dow Jones, is at the top of the list for potential upside. Analysts expect the stock to rise 37.4 percent over the next year.
From the screen, Alaska Air Group is the most popular stock on the Street. 93 percent of analysts covering the stock rate the airline stock as a buy. Analysts believe Alaska Air will increase by 27.7 percent in the next year.
Generac, a power generator company, appears on analysts’ screen and has the best year-to-date performance of the list. As of Wednesday’s close, the stock had gained nearly 80%. Wall Street believes Generac has more room to grow, with a potential upside of 25.4 percent.
Other companies tinclude General Motors, T-Mobile, and PayPal.
Merck, based in New Jersey, and Ridgeback Biotherapeutics, based in Florida, announced on Friday that their antiviral drug, molnupiravir, reduced the risk of hospitalization or death by around 50% for patients with mild or moderate Covid cases. The late-stage trial participants were all unvaccinated and had at least one underlying factor that put them at a higher risk of developing a more severe infection.
“I believe it is real,” Cramer said on “Squawk Box.” “It’s a game changer.”
Merck intends to apply for emergency use authorization for the drug in the United States as soon as possible. Molnupiravir, if approved by regulators, could be the first oral antiviral treatment for Covid.
Rivals such as Pfizer in the United States and Roche in Switzerland are also racing to develop an easy-to-administer antiviral Covid pill. However, so far, only intravenous antibody cocktails have been approved for the treatment of non-hospitalized Covid patients.
“We have to get away from the idea that if you’re not vaccinated, you’re going to the hospital, even though we don’t necessarily want to promote no vaccine. This is the game changer we’ve been looking for,” the “Mad Money” host said, adding that it could make people who are afraid of getting Covid at work less afraid to come in.
Merck’s stock rose as much as 12% to a 52-week high of $84.34. In late 2019, the stock reached an all-time high near $90.
“Merck has significantly underperformed. So, if you bought some Merck here… It’s a great company with a great balance sheet. It has simply underperformed, as have many other drug stocks, according to Cramer. “With the exception of Merck’s cancer portfolio, I don’t like the rest of Merck’s portfolio. But here’s the thing: this is crucial,” he added.