Energy stocks could surge 42% as oil prices extend one-year highs, Fundstrat's Tom Lee says

• The energy sector has 42% upside potential as it plays catch-up to the ongoing surge in oil prices, Fundstrat's Tom Lee said in a note on Tuesday.
• A correlation analysis of oil prices and the energy sector suggests that the SPDR Energy Select Sector ETF (XLE) should trade at $63, Lee said.
• A sustained rally in the energy sector could spark FOMO among investors given the sector only represents 2% of the S&P 500, Lee observed.
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A correlation analysis between oil prices and the energy sector suggest a catch-up trade could be in the works, Fundstrat's Tom Lee said in a note on Tuesday.

Oil prices have extended their gains to more than one-year highs as demand expectations rise for the commodity and supply tightens due to recent production cuts from Saudi Arabia. The energy sector is up 17% year-to-date.

But since the end of 2019, the SPDR Energy Select Sector ETF (XLE) is down 26% whereas oil prices are down just 3%.

Oil and the energy sector are highly correlated, and current oil prices suggest the XLE ETF should trade to $63, representing potential upside of 42% from Monday's close, Lee said. The price forecast is based on a regression analysis of the relationship between oil prices and the energy sector, according to the note.

A continued rally in the energy sector could spark FOMO among investors, as the sector represents just 2% of the S&P 500, Lee noted.

"That level is so small, that it is lower than the weight of many of the individual FANG stocks. And as a consequence, many managers have a zero weighting in Energy," Lee said.

The energy sector remains Fundstrat's #2 favorite sector to invest in for 2021, based on potential supply constraints for oil under the Biden administration, an expected demand recovery as travel and the economy recovers, and the wide-spread disdain among investors for the sector, representing a contrarian buy signal, the note said.

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