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Michael McDonald

Michael McDonald

Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance…

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Despite High Risks, Investors Remain Bullish On Energy

Notwithstanding Monday’s big stock market drop, the outlook for investors is getting cloudier. While President Trump and the Republicans have made many promises that appeal to investors such as corporate tax reform, and easier access to natural resources for E&P firms, the actions that have been prioritized so far, have little relation to business.

The risk for investors is that the new administration may become so bogged down in non-business issues that they are unable to effectively implement their pro-business plan. Yet investors have been largely sanguine nonetheless. A new survey of investor’s sentiment shows investors are largely unconcerned about these political risks.

The survey was put out in late January by Etrade Financial and found particular optimism among energy investors.

Specifically, the survey found:

• Bullish sentiment was at 65 percent, the highest level measured by the survey since Q1’15, and up 20 percentage points from Q1’16.

• Three out of five investors believe the market will rise this quarter, up 26 percentage points from Q1’16.

• More than three out of five investors also believe the U.S. economy is healthy enough for additional rate hikes this quarter, up 16 percentage points from Q1’16.

More importantly for investors, three sectors dominated investors lists as attractive investment areas. In order of greatest investor interest, these sectors were Energy, Financials, and Healthcare.

• Energy. More than half of all investors believe the energy sector offers potential in Q1, up seven percentage points from the previous quarter. Interest in the energy sector is at its highest point in more than a year, perhaps in response to President Trump’s calls to implement pro-energy measures.

• Financials. Investor interest in financials surged 14 percentage points from the previous quarter, rising to 46 percent in Q1. With additional Fed rate hikes expected in 2017, investors may view financials as a sector that could potentially benefit. Additionally, many investors may view the sector favorably due to potential industry-wide deregulation proposed by President Trump.

• Health care. Interest in health care remains high with 42 percent of those surveyed interested in the sector for Q1, perhaps due to the President’s stated determination to repeal Obamacare and push for industry deregulation. Related: Is Deepwater Drilling About To Make A Comeback?

If sentiment is any indication then, the energy sector may have more good days ahead. At the same time, investors need to be wary of taking investment action based solely on investor sentiment. While sentiment may be a bullish indicator in the very short run, it is often associated with longer term declines.

The reality is that the average individual investor earns a return of roughly 4% in their portfolio over time according to the best studies on the topic. That abysmal return is despite a market that has an average return of 10.8% since 1949. The reason individual investors do so badly is that they get emotional and trade too often buying into the market when it is highest, and selling when it is lowest. Thus buying into a stock simply because other individual investors are doing so, is often a bad decision.

None of this is to say that the energy sector does not have a bright outlook ahead of it, or that investors cannot profit from investing in the space – it does and they probably can. However, investors need to be cautious, look at the economics behind the industry, and then make investing decisions accordingly. If the bulk of individual investors are doing that, then the sentiment numbers are positive for the right reason. If investors are just chasing the herd though, they may find themselves part of a pack of lemmings headed over a cliff.

By Michael McDonald of Oilprice.com

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