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Why Energy Investors Shouldn’t Panic Going into Earnings Season

Monday will mark the start of earnings season, the three week period during which the majority of S&P 500 companies report revenue and EPS for the previous calendar quarter. Over the last eighteen months or so that has been a scary time for energy investors as the extent of the pain felt by many companies as the result of the oil price collapse became clear. Once again, much of the focus over the next few weeks will be on the energy sector, and expectations seem to be for more of the same. Those very expectations, though, may provide a clue as to why it might not turn out to be too bad.

In dealing rooms around the world, traders are taught to anticipate and assess what others are doing. When it seems that everybody feels the same way about something you first go with the momentum. After all, if everybody is buying the price will go up. At some point, though, it pays to take a contrarian view. Once everybody is long profits will be taken, and even a relatively small amount of selling into a market that is generally long will quickly reverse that momentum. The same is true in the opposite direction; when a lot of people are short, or at least have held off of buying, any move up will quickly become exaggerated.

After a year and a half of tumbling prices in the energy sector, and with analysts seemingly competing to publish the most negative estimates, it could well be that energy stocks have reached that point. If nothing else it makes it unlikely that bad news will precipitate another major drop. Factset, in their invaluable Earnings Insight, calculate that downward revisions of analysts’ expectations going into this earnings season are at their highest since Q1 2009, with energy being the worst sector. That sounds scary until you realize that the first quarter of 2009 actually marked the low point in the S&P 500.

There is evidence that, just as then, analysts have gone a little too far in their pessimism, particularly when it comes to energy. Both oil and natural gas prices were of course significantly lower over the last three months than in the same quarter last year, around 33 percent lower in both cases. Logically enough then, earnings estimates for this quarter are also lower, but, again according to Factset, they are lower by over 100 percent.

There are reasons why that obvious discrepancy is not as crazy as it first seems. Firstly, since the beginning of 2015 almost every energy company has cut back in some way,…




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