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Energy Strong and Getting Stronger


Sector shows no signs of slowing.

For all the talk and even more dangerous "feel" many of us had – my hand is in the air - in anticipating rotation in this market, especially last week with Technology, the best performing sector for the week was actually Energy.

Over the past month you've probably heard many pound-the-table reversal arguments, supported by Financials and Consumer Discretionary stocks that finally "refuse to go down," and were poised for the sharpest rallies. They've also refused to go up: Those two sectors net out for 0% and that's if I'm kindly rounding up over the past month. Instead the best performing sector was supposedly most vulnerable to a pullback: Energy.

During the second quarter Wall Street wore out its thesaurus coming up with smarter ways to say "watershed moments" and "major turning points," and we had every reason in the world to rotate leadership, and yet the best performing sector has been Energy.

We had every reason but one, that is. Strength.

The Lay of the Land

Stocks in bull markets find ways to wear out sellers and re-write bad news and last longer than most will imagine. Energy stocks were under-owned for years, and their importance around the world economically did not correlate with their weightings in the indexes and trillions that chase them.

Year-to-date, two of every three stocks in other sectors (excluding Energy/Materials) of the S&P 1500 are still looking up, hoping to break even for the year. Even after this monster rally, it won't be easy since those stocks are down an equally weighted average of -16.5%. The Energy stocks in that index are up an equally weighted average of +16.9%.

There's tremendous risk in some of these names. The group is vulnerable to significant pullbacks. I've tightened sell disciplines and stops around some and taken profits in others in my own portfolio that I triple-weighted in Energy when it represented just 6% of the S&P. I expect to routinely pay an expensive price of admission in thesis-shaking volatility. The only guys not available for a quote on how much risk there is in Energy are the ones working on the rigs, overtime.

I do talk to them, the engineers in particular, and there aren't enough of them to do all the jobs, not counting those on the waiting list. That's my kind-of problem. But that was a clear distinction I made in my portfolio. Working on big integrated Energy companies interests me more than working at them.

One To Consider

Jacobs Engineering (JEC) reports another good quarter this morning and offers a view from this perch. Its backlog of orders climbed to $16.2 billion. That number is about 50% more than it was last year and about 50% more than the cost to buy every single outstanding share of the company.

As far back as I looked this morning, the last few years' worth of quarterly estimates were beaten. I would say surprised, but I'm not sure if only eight Wall Street analysts qualify as a consensus. Speaking of un-crowded, I took a peek at two big refiners' stocks, which were held by an average of 1500 mutual funds as of the latest filings. Jacobs was held by less than half as many. The two refiners' shares combined have lost one-third of their value in the last 12 months while Jacobs is up +77%.

Looking to the Future

One of the six structural shifts that I've built core positions around what I call "Engineering the Environment." I believe that we won't run out of oil as long as there are full tanks of innovation driven by profit incentives. What I've been writing about, for the first time recently, is the potential that we get a true challenge to the ethanol myth (I believed we would and now key figures are dropping hints they will) rendering this shift even more significant. The key plank to each of my positions here is my fundamental belief that we will make more efficient use of the energy we already have.

As I shared in Follow the Invoices, I believed the guys hired to work on refineries would be better stocks than the refineries. I also shared the plans for the largest refinery in the country, right in my backyard - the mosquito swamp of Southeast Texas. Since then, the area has become one of the top five hottest real estate markets. In real estate or stocks, I still see ample evidence that the correct answer to the question of just how good or bad never changes – it depends where you look.

For more on energy, check out Hoofy and Boo's always astute report.

Position in JEC.
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