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2006-09-12 :: Energy Update from Morgan Stanley

Below is a cut/paste from a report yesterday (in the midst of the Energy Sell-off) by Morgan Stanley on the Energy Sector.  They continue to view it as being able to outperform the overall market from an earnings standpoint. 

I agree with their analysis.  It is easy to second guess yourself and lose sight of your strategy during a sector correction/rotation, like we see right now.  In spite of Wall Street earnings estimate cuts for the defensive stocks, the momentum investors (who are currently ruling the roost in terms of active trades at the exchanges) are selling the oils and metals (again, in spite of earnings upgrades and affirmations by Wall Street) and putting money into the defensive stocks.  This sort of counter-intuitive momentum move usually lasts a quarter or two before things revert to the fundamentals.  Unfortunately, it can be rather painful to endure while its going on.

“There is currently high correlation between Return
on Sales and P/S and Return on Net Operating
Assets (NOA) and EV/NOA. With the rally becoming
more mature, expectations and relative valuation of the
service and equipment stocks in our coverage universe
have started to become uniform. On 2007
expectations, BJS and GRP are starting to price in
stalling growth while SLB and the subsea equipment
and engineering firms have the highest growth
expectations beyond 2007. We see the international
OCTG segment as the only area where we expect
strong growth beyond 2007, while the market appears
to price in more of a peak. We would therefore expect
the outperformance within this segment to continue.”

During a market like this, we take the opportunities that are given to us.  We sell off certain assets to generate tax losses for taxable accounts to offset future gains.  We reposition within sectors to take advantage of the companies with the best growth possibilities within the sector (like swapping BJS and GRP for SLB, as Morgan Stanley discusses above).  We generate cash from the stocks that perform best in the earliest part of the cycle and hold steady or increase positions within companies that perform best in the later parts of the cycle.

When you see a screen full of red, its easy to lose faith.  That’s not our job, though.  Its our job to provide the best long-term returns possible for out clients, and we have to capitalize upon the opportunities that are present.  That’s what we are currently doing.

More later!

Mark