One 'catch-the-falling-knife' sector play could be a buying opportunity, Wells Fargo strategist says

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Energy stocks are at the bottom of the barrel.

The sector has slipped 4% in the past month, the worst performer of the S&P 500, shut out of the broad market rally that pushed the index to new highs.

The sharp sell-off has one strategist changing his tune on the sector.

“We had, for a multiyear period, been underweight energy and that worked out really well,” Wells Fargo senior global equity strategist Scott Wren said Thursday on CNBC’s “Trading Nation ” show. “But recently here, if you look at things like return on equity, … if you look at things like the energy sector dropped to being only 5% of the total market cap of the S&P 500 which is really a multidecade low, we had felt that our underweight position was no longer warranted.”

Wells Fargo changed its sector allocation on energy to favorable from unfavorable on April 24. Since then, the XLE energy ETF has fallen 7%.

However, Wren says investors and analysts have been too pessimistic on energy stocks, and expectations need to be recalibrated.

“When oil came off and dropped down into the mid-$40s [a barrel] last fall we thought that analysts reduced their earnings estimates way too much. They really haven’t boosted them back to reflect this close to $60+ level,” said Wren.

At the end of December, analysts surveyed by FactSet estimated full-year 2019 earnings growth on the XLE of 7%. By the beginning of May, full-year earnings estimates had been slashed to forecast a decline of 9%.

“You could make the argument that this was kind of a catch-the-falling-knife sort of call, but it looked cheap and we wanted to stick our toe in the water. So that’s what we did,” said Wren.

Aside from energy, Wren favors financials, industrials, tech and consumer discretionary. The financials, technology and discretionary sectors have outperformed the market over the past month with a gain of more than 3% compared with the S&P 500’s 2% increase; the industrials have slightly lagged overall gains with a 1% advance.

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