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Don’t Underestimate The Energy Sector

By Robert Rapier on April 18, 2017

Today I want to touch upon one final theme from my presentation at this year’s annual Investing Daily Wealth Summit. Ponder this question for a moment: How has the energy sector fared long-term compared to the other sectors of the S&P 500? 

In speaking with investors, I find that the energy sector often gets a bad rap. That’s because we investors can have short memories. Too frequently we flock to a hot sector until the bubble bursts, and then we go searching for the next hot sector. But we sometimes lose sight of how detrimental this sort of sector-chasing can be to our portfolios. Allow me to demonstrate.

Exchange-traded funds (ETFs) are investment funds that trade on stock exchanges. Select Sector SPDRs are ETFs that divide S&P 500 stocks into ten sector index funds. Nine of the ten index funds commenced trading on 12/16/1998. The 10th, the Real Estate Sector ETF (XLRE), started trading in October 2015.

If you had invested money in one of these ETFs near the end of 1998, where might you have put that money? Technology? Health care? Financials? Certainly not in the energy sector, because oil prices had traded in a narrow band around $20/bbl for most of the previous decade.

Thus, you may be surprised to learn that as of year-end 2016, in addition to being 2016’s top performer (also surprising?), the top-performing all-time Select Sector ETF is the Energy Select Sector SPDR ETF (XLE), with an annualized average return of 8.56%:

 

By comparison, the Technology Select Sector SPDR ETF (XLK) and Health Care Select Sector SPDR ETF (XLV) have all-time average annual returns of 3.81% and 7.48%.

The reason is that despite generating huge returns at times, these sectors have experienced major corrections that wiped out years of positive returns. The technology stock bubble of 1999 to 2001 wrecked long-term returns in the technology sector for more than a decade. Even if you had invested in a great company like Cisco Systems (NASDAQ: CSCO) in late 1999 through the end of 2000, you would be still sitting on losses even after holding it for 17 years. Think about that before you go chasing a high-flier like Tesla Inc (NASDAQ: TSLA).

The energy sector has also had a couple of major corrections over the past 20 years, but this was a time period that saw oil prices move up significantly from the long-range average of around $20 a barrel (bbl). The “normal” price for oil is now significantly higher than it was two decades ago, and the long-term performance of energy sector companies reflects this. Of course, if you invested in the energy sector in mid-2008 or mid-2014 — both time periods just before oil prices collapsed — you are probably still nursing losses.

But the question going forward is whether $50/bbl is the new normal. Long-term, I don’t think so. I don’t think a price below $50/bbl is sustainable for very long. That’s why, following last month’s drop below $50 a barrel (bbl), I reiterated Buys on several quality oil companies in The Energy Strategist portfolio. In the short term at least, this looks like the right decision. Since then oil prices have recovered back to above $50, and the fundamentals seem to indicate higher prices for the rest of the year.

As an investor, I learned long ago that it’s tough to time the markets. I learned to be a deliberate and patient investor. I place my bets and then wait until either my thesis bears fruit or the fundamental outlook changes.

One thing is certain. The world’s appetite for energy will likely continue to grow. History suggests that if you aren’t investing in the energy sector, you could be missing out on long-term market-beating returns.

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  1. avatar
    Dom Brunone Reply April 21, 2017 at 5:35 PM EDT

    Crude looks as if its going down for the count. If OPEC can’t pull Russia into the fold next month, we could see $40 long before we see $60, and the XLE will go down proportionately.