Energy Sector off to a good start in 2025

[dan_s]

Large cap Energy is up 5.9% relative to the S&P YTD and is the only sector to gain during last Friday’s selloff. Strong growth and too firm inflation have led to expectations of fewer rate cuts in ’25 and concerns that financial conditions may need to tighten materially, weighing on most risk assets. Energy, along with other Deep Cyclicals, is more leveraged to fast growth, and all sectors within the group (Energy, Industrials, and Materials) have outperformed the broad market YTD.

In terms of what factors could have the largest impact on Energy, Value is the standout. Energy has the greatest exposure to the Value factor, particularly Realized Value (rather than value based on expected forward revenue and earnings growth). Value returns have been volatile over the past few months, and that has continued YTD. Over the past week Value performed better and should do well in a backdrop of strong growth and higher yields. Value as a contributor to Energy is a longer-term story, though. For now, strong growth and increased oil prices are the driver.

Rebounding oil prices over the past few weeks are one of the major macro drivers of the Energy recovery. There is a strong correlation between Energy Sector performance and oil prices, and that relationship has been stronger than normal since 4Q24. Oil demand remains robust and US oil inventory has been falling, a combination that favors net long positions.

Within Energy, fundamental factor sensitivity has been higher, both positive and negative, over the past two weeks. Earnings Growth, Realized Value, and Growth Momentum have all had a strong influence on Energy names. Quality and risk factors have the most negative betas within Energy.

Increasing natural gas and NGL prices are also drawing more attention.

Breaking down Energy performance over the past few quarters and so far in 2025 shows PEs remain the largest contributor to returns. Revenue estimates remain negative and have been a drag on the sector, but margins have stabilized and moved modestly higher. With Energy fundamentals expected to improve, margins and sales should shift to being a support for the sector. In addition, cash return yields within Energy are the highest of all S&P sectors.