One major market narrative over the past couple of months has been deterioration in terms of the economic outlook. This is due to people becoming less optimistic about the Democrats being able to successfully pass their $3.5 trillion reconciliation package, the end of stimulus-fueled spending, increasing inflationary pressures, and the inability to fully tame the coronavirus.
Thus, all sorts of assets tied to the economy returning to normal have turned lower such as travel stocks and even consumer spending-adjacent areas. One notable exception have been energy stocks which have been demonstrating impressive relative strength. And, this is across the energy complex - oil is above $70 per barrel, natural gas is above $5 per cubic feet, and even the usual laggards like coal and uranium have been rallying.
Of course, this is quite unusual as energy demand is closely tied to the broader economy. Therefore, it's unsustainable for these different groups to trend in opposite directions. While, it's certainly possible that energy could move lower, there's more evidence to support that growth could pick up and energy could break out. Here are a couple of reasons to expect this outcome:
Consolidation
In bull markets, consolidations tend to resolve higher especially when fundamentals are improving. This is certainly the case as energy demand continues to rise even with the coronavirus continuing to linger. Further, it should rise even more when the virus does recede as air travel remains impaired. On the supply side, capex continues to be low, while inventories are falling as well.
Delta Variant Peak?
The delta variant ruined hopes that this summer would bring the normalization of the economy and unleashing of pent-up demand. However, it has been successful in terms of increasing the vaccination rate and many states which were hardest-hit like Florida and Louisiana are seeing case counts drop sharply. This is a positive sign for the economy and energy demand.
Attractive Fundamentals
By looking at the fundamentals of energy stocks, it's clear that investors don't believe that energy prices are going to rise much more as they are priced at very low valuations. This could be another source of upside if oil prices remain at current levels or move higher. For example, many oil companies trade at P/FCF levels in the single-digits which is certainly a rare circumstance.