How to invest in the cheapest sector of the stock market for long-term gains

By Philip van Doorn

The current downcycle for energy prices is setting up an opportunity for patient investors, according to money managers at Gabelli and ClearBridge

Cheniere Energy of Houston is the world's second-largest producer of liquid natural gas.

For contrarian investors who believe the broad stock market is overvalued, the energy sector beckons. But you will need to patient. And if you believe that demand for electricity to power data centers and artificial intelligence is going to balloon, veteran energy market analysts have four specific stock picks for you.

Let's set the stage by looking at forward price-to-earnings valuations for the 11 sectors of the S&P 500 SPX. These are prices divided by consensus earnings-per-share forecasts for rolling 12-month periods, weighted by market capitalization. The sectors are sorted from lowest current valuation to highest, with the full index at the bottom.

   Sector or index           Forward P/E  2025 return  3-year return 
   Energy                           15.4         7.5%          19.6% 
   Financials                       16.7        12.6%          70.6% 
   Healthcare                       16.8         0.8%          14.5% 
   Real Estate                      18.0         5.7%          10.6% 
   Utilities                        18.2        13.0%          22.2% 
   Communication Services           20.3        17.9%         121.5% 
   Materials                        20.6        11.6%          27.3% 
   Consumer Staples                 22.5         5.5%          24.4% 
   Industrials                      24.4        16.1%          68.1% 
   Information Technology           29.2        14.0%         122.1% 
   Consumer Discretionary           29.3         2.0%          52.9% 
   S&P 500                          22.3        10.8%          67.7% 
                                                     Source: FactSet 

All total returns in this article include reinvested dividends.

The energy sector of the S&P 500 remains the cheapest on a forward P/E basis. It has lagged behind the full index this year, and its three-year return of 19.6% has been less than a third of the return of the full S&P 500.

'We are underinvesting in oil.'Sam Peters, ClearBridge Investments

The Energy Select SPDER ETF XLE is designed to mirror the performance of the S&P 500 energy sector by holding all 22 stocks weighted by market cap. But you might want to take a more selective approach to the space and expand your horizons beyond this small group of stocks.

During an interview with MarketWatch, Simon Wong, an energy-sector analyst at Gabelli in New York, who also co-manages the Gabelli Utility Trust GUT and the Gabelli Asset Fund GABIX, said crude oil was likely to be rangebound between "the high $50s and the low $70s," in part because "the Trump administration doesn't like high oil prices."

"Every time there are high oil prices," President Donald Trump "seems to find a way to knock [them] down through social-media postings, press conferences or what have you," Wong said.

Continuous front-month contract prices for West Texas Intermediate crude oil (CL.1) on the New York Mercantile Exchange declined to $65.77 early Tuesday from $71.72 at the end of last year, although they hit an intraday high of $79.39 on Jan. 15, before Trump began his second term as president on Jan. 20. Prices also spiked in June. Here's a year-to-date WTI chart:

What might be more important than Trump's musings has been the market's expectations for increasing supply at a time when demand in China for crude oil is "not growing, or even declining," Wong said. "And demand in India is flat year-over-year. We had been expecting 3% to 5% growth in demand."

Wong also expects OPEC countries "to add back about 2.2 million barrels a day by the end of this year" to the world's crude-oil supply, he said, as the cartel unwinds production quotas.

And then there is Guyana, where budding offshore projects led by Exxon Mobil Corp. (XOM), Chevron Corp. (CVX) and CNOOC Ltd. (HK:883) are expected "to add about 1.5 [million] to 1.6 million barrels a day in incremental supply," Wong said.

All of these factors led Sam Peters, a portfolio manager at ClearBridge Investments in New York, who was also interviewed for this article, to say that the stock market was "already discounting $50- to $55-a-barrel oil."

Peters has co-managed the CearBridge Value Fund LMNVX since 2010.

The liquid natural gas trend

This year natural gas (NG00) has also declined, to a front-month price of $2.888 MMBtu early Tuesday from $3.098 at the end of last year. But an investment in natural gas is not only about commodity prices. It is also about the rapid expansion of U.S. export capacity.

"I like natural gas," Wong said. "It has pulled back recently because of supply coming online. But looking out three to five years, there is greater demand for natural gas from data centers," he said.

There have been endless predictions of stress on power grids as data centers are constructed to support the development of artificial intelligence technology. Nvidia Corp. (NVDA) has been the most obvious beneficiary, as it continues to dominate the market for high-end graphics processing units, or GPUs.

Peters described all of the generative AI data collation as "incredibly energy-intensive."

"We are taking electrons and turning them into inference," he said.

"The general consensus is bullish for natural gas and bearish for oil," Peters said. "Much of the energy supply for AI will come from natural gas."

The enthusiasm for natural gas is particularly important for U.S. exporters, Peters said. He predicted "big leaps" in 2026 and 2027, when "we are going to add about 3 billion cubic feet of U.S. LNG export capacity."

Wong named National Fuel Gas Co. (NFG) - the largest energy-sector holding of the Gabelli Asset Fund - as being "well-positioned to take advantage of rising demand for natural gas and higher prices."

Most of NFG's gas production takes place in western New York and in Pennsylvania, which is an advantage because "Philadelphia is the data-center hotbed," Wong said.

Wong favors Cheniere Energy Inc. (LNG) - the largest U.S. producer of liquid natural gas and the world's second largest, after Qatar. The company is based in Houston and operates large marine export facilities in Cameron Parish, La., and Corpus Christi, Texas, along with gas pipelines.

Wong also likes Kinder Morgan Inc. (KMI), a pipeline and terminal operator, as a long-term investment.

Peters cited EQT Corp. (EQT), which describes itself as the only vertically integrated U.S. natural-gas producer. He is also enthusiastic about LNG and KMI, but described EQT as "a bit spicier" because it is "more leveraged."

Back to oil

"Oil is the flipside of gas. Everyone is negative on oil. Where gas has demand pull, the oil bearishness is based on oversupply into next year," Peters said.

"The culprit is OPEC. Saudi Arabia got tired of cheating by its OPEC partners," after production quotas had been set to prop up prices, he said.

'Every time there are high oil prices,' President Donald Trump 'seems to find a way to knock [them] down through social-media postings, press conferences or what have you.'Simon Wong, Gabelli

With the market already laying the foundation for $50 oil prices, it is possible investors will see another leg down for shares of oil producers, for an attractive entry point.

Leaving precise investment timing aside, Peters believes this chart makes the long-term case for oil:

On the left, the chart shows that capital expenditures had increased when U.S. supplies were low. This was reversed staring in mid-2014, when the great expansion of U.S. shale production led into a long decline for crude-oil prices into early 2016. On the right side of the chart, you can see an increase in expenditures starting in 2022.

With so much new supply coming online, Peters said "the wildcard for next year is shale backing off." U.S. producers who were burned during the 2014-16 oil-price decline, when there was a flurry of bankruptcies and consolidation among smaller industry players, have been careful with capital spending ever since.

"U.S. Shale production has neem plateauing at current prices," Wong said.

And the Baker Hughes U.S. oil rig count was down 9% from a year earlier, as of Aug. 22. Peters said that the May rig count was down 11% from a year earlier.

"I personally believe the shale cutback is underestimated and that U.S. barrels will increasingly be flat to declining as we get into 2026," Peters said, describing the decline as "a nice offset" to increasing supplies coming from outside the U.S.

With shale production at a late stage and with his opinion that "we are underinvesting in oil," Peters remains a long-term bull. And here are his two favorite ways to play it:

Peters described Schlumberger Ltd. (SLB) as "quality when nobody wants it." The stock trades at a forward P/E of 12.3 and has an an estimated free-cash-flow yield of 11.28%. That is based on the closing price of $36.84 on Friday and the consensus 12-month estimate of $2.92 in free cash flow per share. among analysts polled by FactSet. The stock has a dividend yield of 3.09%, so there is plenty of excess cash flow to cover a dividend increase, according to the consensus estimate. Schlumberger's free cash flow for the past 12 months has been even higher, at $3.52, according to FactSet.

Peters described free cash flow as "a robust lens" for investors. Despite the current downcycle for prices, he called SLB "a great investment for the next decade." He added: "And if I am wrong, I get the free cash flow now. I am doing OK - it is Investing 101."

He also likes Chevron in the wake of its acquisition of Hess, which was completed in July and made the company a major player for Guyana offshore production.

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09-02-25 1042ET

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