Energy has been the strongest performing sector in the S&P 500 so far this year, rising 20% year to date, but Morgan Stanley says valuations are now much closer to long-run norms, making further gains more dependent on earnings revisions than multiple expansion.
While part of the rally reflects higher oil prices, there has also been “notable multiple expansion across much of the sector alongside a broader cyclical rotation,” analysts led by Devin McDermott said in a note.
Dive deeper into sector outlooks with InvestingPro - get up to 50% off Energy is now trading at a roughly 43% discount to the broader market, compared with about 53% at the start of the year and versus a pre-Covid median discount of around 35% between 2010 and 2019.
Integrated and Services have led the move higher, the analysts note. Integrated majors are now trading back in line with their long-run relative multiples versus the market, while Services have returned to near five-year averages.
At the same time, forward EV/EBITDA multiples for Integrated Oil & Gas are at the 95th percentile since 2010, according to the bank’s data.
With valuations no longer deeply discounted, analysts argue that “further upside increasingly hinges on positive estimate revisions, but the nearterm fundamental backdrop is still somewhat soft.”
The bank expects the oil supply-demand picture to improve from 2027 onward, but warns that “the surplus is still likely to get worse before it gets better.” Oil prices have been in a “clear downtrend for the last year,” the analysts say, and much of the recent strength has been tied to geopolitical uncertainty rather than improving fundamentals, leaving risks “skewed to the downside over the coming months.”
Global oil and product inventories have built by more than 400 million barrels over the past 12 months, with OECD stocks expected to rise in 2026, a dynamic analysts think should pressure Brent and WTI prices.
Earnings revisions breadth has also been uneven. Most major sub-sectors have experienced negative relative revisions, with E&Ps and Integrateds among the weakest, while Services show “some pockets of positive revisions,” the note says.
Hedge fund positioning is elevated in Services and Integrateds, but exposure to E&Ps and Midstream remains subdued.
Against that backdrop, Morgan Stanley advises investors to be cautious. “We recommend sticking with a defensive playbook for now, and would wait for a pullback before broadening exposure,” they wrote.
