Don't Dismiss Energy, Small-Caps
Here's why a reversion to the mean should favor these two in the second half of 2024.
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Well, if nothing else, I am in good company with my cautious outlook around the overall market. Much like Berkshire Hathaway BRK.B, I have more of my portfolio in cash and short-term Treasuries than I have had for many, many years. I am also increasing my exposure to the energy sector. I haven’t amassed nearly a 30% stake in Occidental Petroleum OXY like the Oracle of Omaha has, but I do own it. I also own names like Exxon Mobil XOM and the Energy Select Sector SPDR Fund ETF XLE within covered call positions.
We potentially started to see some sector rotation on Monday with banks and energy outperforming. Nvidia NVDA, after briefly becoming the most valuable company in the world by market cap late last week, had stumbled a bit. The artificial intelligence juggernaut gave back 13% of its value over three trading sessions before recapturing half of those losses in trading on Tuesday. The semiconductor maker is up over 150% so far in 2024 and worth more than a $1 trillion more than all the energy companies within the S&P 500 index combined. This is one of my favorite signs that something is clearly amiss with the overall market.
As we approach the halfway point of the year, there are several things I think that will happen in the second half of the year. I believe the conflict in Ukraine will escalate further. The crisis that is happening around a good part of the commercial real estate sector will also become more obvious. Even the New York Times had a good article yesterday on how more banks are taking haircuts on loans that are current in order lower their exposure in their loan books to this part of the economy.
I also think the market is overdue for some significant sector rotation as the rally this year has been extremely top heavy. Nvidia by itself has contributed approximately a third to the overall market gains so far in 2024. This was after the Magnificent Seven accounted for some two thirds of the rise in the S&P 500 in 2023. Obviously, if the rally in equities is to continue it is going to have to broaden at some point.
Energy is one sector I believe can rebound after being a laggard in the second quarter of this year. Small-caps are another part of the market that should outperform in the second half of the year based on reversion to the mean trading action happening given the divergence of performance in the first half of this year. While both the S&P 500 and Nasdaq are sporting returns in the mid-teens so far in 2024, the small-cap Russell 2000 is flat for the year.
Small-caps could play catch up in the third and fourth quarters. In my column Friday, I will highlight some small-cap names I have been accumulating recently. In my weekend column, I will put forth a covered call trade idea that will benefit if small-caps behave better in the coming months.
At the time of publication, Jensen was long OXY, XLE and XOM.
