Oil stocks are finally playing catch up as the energy sector has become one of the best performing sectors of the market this year, according to Morgan Stanley. “An improving macro backdrop has started a catch-up trade for Energy,” analyst Devin McDermott told clients in a research note Thursday. The sector lagged the broader market last year as crude sagged, but is now following oil prices higher. After lagging crude prices in the first quarter this year, energy finally closed the gap this month and outperformed the commodity by about 5%. The sector rose 10.3% in March, while U.S. crude gained about 6% and global benchmark Brent rose 4.5%. Energy is now the third best-performing space in the market behind only communication services and tech, according to McDermott. The sector is outperforming the broader market with energy up 12.5% year to date while the S & P 500 is up 10.1%. Morgan Stanley upgraded the entire sector to overweight early this week. Energy is also comparatively cheap, trading two times lower than its historical valuation vs. the S & P 500. The sector offers free cash flow and shareholder return yields that are as much as three times higher than the broader market, McDermott told clients. The analyst raised price targets for Morgan Stanley’s coverage by a median of 3%. He is recommending quality trades such as ConocoPhillips , Occidental , Diamondback and Devon . “Beyond the improving macro backdrop, we expect the growing capital efficiency divide across the industry to continue to drive relative stock performance this year,” McDermott wrote. And the sector still has room to run with Morgan Stanley forecasting that crude will move higher on stronger demand and lower supply, resulting in an 800,000 barrel per day deficit in the third quarter. The investment bank is now projecting that Brent will rise to $90 a barrel, compared to $80 previously, in the second or third quarter driven OPEC+ production cuts
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