Should energy’s ‘lonely rally’ in September worry the stock-market bulls?

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U.S. stocks have been on a bumpy ride higher in 2021, but energy’s “lonely rally” in September isn’t a sign of the market peaking despite some investor jitters, according to analysts at JPMorgan Chase & Co.

“Last month the energy sector rose over 9% in a declining market and was the only sector up in the S&P 500 index,” the analysts said Thursday in a J.P. Morgan research note on U.S. equity strategy. The S&P 500 fell almost 5% in September, its first monthly drop since January, according to FactSet data. 

“This unusual divergence of sector performance has led some to suggest that the market has peaked and is primed for a major correction,” the analysts said in the report. But “we remain constructive on equities,” they wrote, with energy still being “one of our favorite sectors.”

Recent spikes in oil and natural gas prices have pushed energy stocks higher, with the sector shining amid volatility in the U.S. equities market. The S&P 500’s energy sector

has soared more than 45% this year, far exceeding the broad index’s rise of more than 17%, based on Thursday afternoon trading, according to FactSet data. The Energy Select Sector SPDR Fund also was up 45% for the same stretch.

Read: Stock market can absorb $130 oil, JPMorgan’s Kolanovic says

“Higher oil is generally positive for large-cap equities since major oil producers in the U.S. are public,” the J.P. Morgan analysts said, while the burden of rising energy costs is “dispersed across the economy” to households, businesses, government and oil importers.

“All else equal, rising oil prices will certainly weigh on some sectors that are directly tied to discretionary spending,” the analysts wrote, “or use energy as an input/feedstock,” such as airlines, trucking and chemicals.

Read: Natural-gas prices extend pullback from multiyear highs; oil futures edge higher

As broad benchmarks for U.S. stocks have climbed in 2021, rotations between styles and sectors have stirred volatility in the market along the way, said Liz Ann Sonders, chief investment strategist at Charles Schwab, in a phone interview Thursday. Around 91% of constituents in the S&P 500 index have seen a correction of at least 10% from some high point this year, she said.

“Don’t try to front-run sector rotations,” said Sonders. Instead, investors might rebalance their portfolios more frequently in this choppy environment so that they’re trimming profits during times of strength and “adding into weakness.” 

Energy remains attractive from a standpoint of risk and reward, according to the J.P. Morgan analysts, who cited strengthening fundamentals and “low valuation relative to the market.” 

“Since S&P 500 Energy is compositionally weighted towards quality integrated and refiners, pure-play E&P and service should see even stronger growth under $80-100 oil scenarios,” they wrote in their report. “Small-cap energy offers the strongest upside given its higher gearing to oil, balance sheet recovery, and potential M&A targets as larger peers look to strategically build-up reserves.” 

The S&P 500 index was up 1.1% Thursday afternoon, with its energy sector showing a similar gain, according to FactSet data, at last check. The Russell 2000 index

a measure of small-cap stocks, was showing a larger rise of 1.7%.

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