Happy Holidays and all the best for the new year! We appreciate all your support and help in making 2024 another successful year for Siegel Asset Management (SAM) Partners.
THE HAVES (MIDSTREAM) AND HAVE NOTS (UPSTREAM OIL AND GAS)
Our 2023 year-end market commentary headline read, “Traditional Energy to Bounce Back in 2024.” Well, the energy sector has been one of the worst performers among the 11 S&P 500 sectors posting a total return of just 6%.* This compares with 28.5% for the S&P 500. But we were right! Traditional energy has bounced back, the Alerian Midstream Index (AMNAX) returned ~43% and SAM Partner’s Infrastructure Income Portfolio has generated a
year-to-date return of ~36%.*
The energy sector has been a tale of haves and have nots. Stocks of upstream companies whose fortunes are tied to commodity prices fared poorly in contrast to midstream or infrastructure companies that provide services to producers and end use markets. The narrative has changed. Investors have come to recognize what we’ve been writing for several years: the world still needs fossil fuels—oil, natural gas, and yes, even coal.
Decarbonization (the energy transition) will take longer and be more expensive than many proponents have envisioned. While this reality is finally being recognized, it is not meant to imply the demise of clean energy. The clean energy train has left the station, and the destination remains a net-zero greenhouse gas (GHG) emissions world. It’s just going to take longer and include fossil fuels. We suspect that most companies will stick to their aspirational emissions reduction targets, albeit the challenge is realizing them.
OUR BOTTOM LINE: STICK WITH MIDSTREAM ENERGY STOCKS
Midstream energy provides the infrastructure to support AI and buildout of data centers (see market commentary). Artificial intelligence (AI) and natural gas were the big story in 2024. AI and data centers continue to be the dominant thematic in the stock market and will require substantial amounts of around-the-clock electricity to operate. There’s a sense of urgency around the construction of data centers to support AI development and ensure the U.S. remains a leader in AI technology.
Capital expenditures are cool again. There have been two key inflection points over the past several years. The first was the energy industry’s pivot away from undisciplined spending to chase growth; the second is investor recognition that the useful life of oil and gas infrastructure will extend well into the future. Hence, investors are now embracing companies that are judiciously increasing capital expenditures with financial guardrails—those that focus on high-return projects financed with internal funds. In our view, large projects that cannot be financed internally should still be pursued, but with partners.
Paradigm shift justifies higher valuations. Some have observed that the midstream energy stocks are trading near historical averages and have grown more cautious. The old Wall Street adage, “the easy money has been made” is likely true. However, historically, the midstream sector has traded at even higher valuations. We would argue that the paradigm shift we’ve discussed in previous commentaries—disciplined growth, strong balance sheets, attractive returns on investments, and returning more cash to shareholders through dividends and stock buybacks—justifies higher valuations moving forward.
Dividend yield plus growth make midstream an attractive holding in portfolios. The combination of midstream yield and dividend growth offers potential returns over 10%, along with additional capital appreciation driven by valuation multiple expansion. SAM Partner’s Infrastructure Income Portfolio offers a 4+% yield with expected dividend growth of 5-7%.
A GLANCE BACK AT 2024
Trump's victory. The win is seen as favorable for traditional energy (fossil fuels) and less so for clean energy. While his administration pushes a pro-growth agenda, potential higher tariffs could drive inflation, contributing to a higher ten-year treasury yield and a more cautious Federal Reserve.
S&P 500 performance. As of December 17th, the S&P 500 was up ~27%, with a total return of ~29% YTD, following a 26.3% return in 2023. Growth stocks, particularly the "Magnificent 7," continued to outperform value stocks like energy.
Russell 1000 growth outperforms value stocks in 2024. The Russell 1000 Growth Index gained 38% YTD, significantly outperforming the Russell 1000 Value Index, which was up 14% as of December 17th.
Source: Bloomberg
Federal Reserve rate cuts. The Fed cut rates by 0.5 percentage points in September, followed by two additional cuts in November and December, bringing the federal funds rate to 4.25-4.50%. Despite these cuts, the ten-year treasury yield rose from 3.9% to 4.5%.* The Fed’s hawkish stance, citing inflation concerns, led to market weakness and a more cautious outlook, with only two rate cuts expected in 2025, down from four expected as recent as September.
US LNG exports.
a. In January, the Biden administration paused issuing new LNG export permits to non-free trade partners. This decision does not affect current exports or projects under construction. The DOE's updated study criticized the growth of LNG exports, but with Trump’s stance on U.S. energy exports, this may have limited impact.
b. Exports remained flat in 2024.
Energy sector performance. Energy continued to be one of the worst-performing sectors in the S&P 500, despite strong midstream performance. Investors favored growth stocks, and subdued commodity prices weighed on the sector.
Source: S&P Global and Bloomberg (date as of 12/17/24)
Commodity prices were subdued. WTI crude oil prices dipped as low as ~$67 per Bbl in September and as high as $88 per Bbl in April. It currently stands at ~$70 per Bbl,* which is essentially flat with year-end 2023 levels. Notwithstanding the one-day blip in January, Henry Hub natural gas prices spiked to ~$3.40 in November and bottomed at $1.10 per MMBtu also in November.
US oil production grows, natural gas dips: US oil production continued to rise, albeit at a slower pace, while natural gas production saw a slight decline as producers reduced output due to low prices. The US remains the world’s largest producer of oil and natural gas.
OPEC+ supports crude market: OPEC+ has kept production quotas lower since November 2022 to support oil prices. At its December meeting, the group decided to delay gradual production increases planned for January 2025 until April 2025.
A LOOK AHEAD AT 2025
1. Don’t expect an S&P 500 three-peat in 2025. After back-to-back ~25% total return gains in 2023 and 2024, we expect more modest returns in 2025. Valuations are historically rich as the S&P 500 currently trades around 22 times expected 2025 corporate earnings per share.
2. Fed likely to go slow in reducing the fed funds rates. The Fed’s December update of its dot plot shows just two rate cuts of 25 basis points next year. The new projection would bring the federal funds rate to a range of 3.75% to 4% by year end, down 150 basis points from its peak. Core inflation is not expected to reach the Fed target of 2% until 2027, essentially pushed out one year.
3. LNG pause likely to be lifted. Trump has indicated that he would lift the pause. Further, according to Bloomberg, “Trump warned the European Union that its exports will get hit with US tariffs if its member states don’t buy more American oil and gas.”
4. Permit reform legislation enacted. Congress is likely to pass legislation that will facilitate the issuance of permits for pipelines and transmission lines and restrict frivolous lawsuits that impede issuances. This is vital to ensure the timely development of AI and data centers.
5. Environmental Protection Agency (EPA) emissions rules likely to be eased. However, state clean air mandates are unlikely to change.
6. Midstream energy returns should be very competitive. Against the backdrop of expected normalized stock market returns next year, midstream energy stocks should provide competitive returns given yield plus dividend growth approximating low double-digit returns.
7. OPEC+ the wild card. The biggest risk for energy stocks is OPEC's continued willingness to cede market share to production growth from non-OPEC countries. We believe they will likely maintain this support.
8. US economy remains the envy of the world. US GDP is widely expected to remain strong around 2%, but down from projections of 2.5% in 2024.
COP29: FOCUS ON FINANCING CLIMATE CHANGE INITIATIVES
The 29th annual Conference of the Parties (COP29) to the United Nations Framework Convention on Climate Change was held in Baku, Azerbaijan, from November 11-22. With over 65,000 participants, the summit made progress, particularly in securing financing for climate change initiatives. However, a major concern was whether climate action in the U.S. would continue following Trump's election victory.
KEY TAKEAWAYS FROM COP29
New collective quantified climate finance goal (NCQG). An NCQG was agreed on by countries to replace the previous $100 billion annual commitment set in 2009. The new target was increased by $300 billion annually from developed countries by 2035, with a total target of $1.3 trillion per year from all sources, public and private.
Article 6 negotiations progressed the development of efficient/effective carbon market mechanisms. Specifically, Article 6.2 regulates bilateral carbon trading between countries and Article 6.4 establishes a global crediting mechanism for emissions reductions.
Nations failed to agree on binding commitments to phase out fossil fuel subsidies. All countries are required to submit new national climate plans (NDCs) in Q1 2025 with some countries encouraging members to aim for more ambitious targets.
NOVEMBER REVIEW: ENERGY DELIVERS STRONG GAINS POST TRUMP VICTORY
The rundown:
In November, SAM’s Infrastructure Income Portfolio produced a return (net of fees) of 16.4% compared to 5.9% for the S&P 500 and 7.8% for its customized benchmark. Year-to-date, SAM’s Infrastructure Income Portfolio produced a return (net of fees) of 50.7% compared to 28.1% for the S&P 500 and 34.6% for its customized benchmark.
In November, SAM’s Energy Transition Portfolio generated a return (net of fees) of 14.9% versus 2.5% for its customized benchmark. Year-to-date, SAM’s Energy Transition Portfolio generated a return (net of fees) of 31.0% versus 13.6% for its customized benchmark.
SAM’s portfolios are more heavily weighted in Midstream, which has outperformed relative to utilities and the clean energy sector in November and year-to-date.
Midstream outperformed and was up in November with a total return of 14.4%, as measured by the AMNAX.
In November, utilities and the clean energy sector underperformed the overall market, generating a total return of 1.5% and -5.4%, as measured by the Philadelphia Stock Exchange Utility Index (XUTY) and the S&P Global Clean Energy Index (SPGTCLTR), respectively.
All sectors in the S&P 500 reported positive performance with consumer discretionary as the best performer and healthcare as the worst. Energy delivered a 6.9% monthly total return. November month-end WTI crude oil and Henry Hub natural gas prices were $68.26 Bbl and $3.39 per MMBtu, down ~2% and up ~86%, respectively from last month.
RESULTS: SINCE INCEPTION & ONE YEAR
SAM’s Infrastructure Income Portfolio produced a return (net of fees) of 146.3% and 49.2% for the periods since 11/10/20 inception and 1-year, respectively. This compares to a total return of 131.8% and 37.9%, respectively, for its customized benchmark and 81.0% and 34.4%, respectively, for the S&P 500 as of 11/29/24.
SAM’s Energy Transition Portfolio generated a return (net of fees) of 32.1% and 34.2% for the periods since 4/29/21 inception and 1-year, respectively. This compares to a total return of 27.5% and 19.3%, respectively, for its customized benchmark and 51.3% and 34.4%, respectively, for the S&P 500 as of 11/29/24.
Source: Bloomberg, NASDAQ and S&P Global
Sam Partners’ Infrastructure Income and Energy Transition Strategies seek to provide sustainable income and growth with capital preservation. This is accomplished by investing in a concentrated portfolio of high-quality midstream energy companies, utilities and clean energy companies that are well positioned to participate in the energy transition to a net zero carbon future. A diversified approach to investments across these sectors should optimize risk-adjusted returns, in our view. Our Infrastructure Income Strategy offers investors a current yield of ~4.0% and growth potential of ~5-7%; while the Energy Transition Strategy that is more heavily weighted with clean energy stocks and aligns with favorable ESG ratings, offers investors a current yield of 4%. In a world searching for yield, we believe these Strategies offer a compelling value proposition.
IMPORTANT DISCLOSURES
Siegel Asset Management Partners is a registered investment adviser located in Plainview, New York. The views expressed are those of Siegel Asset Management Partners and are not intended as investment advice or recommendation. This material is presented solely for informational purposes, and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. Information is obtained from sources deemed reliable, but there is no representation or warranty as to its accuracy, completeness, or reliability. All information is current as of the date of this material and is subject to change without notice. Third-party economic, market or security estimates or forecasts discussed herein may or may not be realized and no opinion or representation is being given regarding such estimates or forecasts. Certain products and services may not be available in all jurisdictions or to all client types. Unless otherwise indicated, Siegel Asset Management Partners' returns reflect reinvestment of dividends and distributions. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results.
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