In 2012, all 10 GICS sectors finished in positive territory, but
So far in 2013, it has been the hottest sector. Is it time to
jump back in?
2012 proved to be a very challenging year for energy firms.
Although the sector, as measured by the Energy Select Sector SPDR
Fund (NYSEArca:XLE), eked out a 2 percent gain for the
calendar year, it was the worst-performing sector in the S&P
500, lagging the best performer, the Financial Select Sector SPDR
Fund (NYSEArca:XLF), by 23 percentage points.
Before we try and determine if this latest rally has legs, it's
important to note that wild year-to-year performance swings in the
energy sector are hardly a surprise.
Over the past 10 years, energy has been either the best- or
worst-performing sector seven different times-more than any other
sector by a wide margin. It should also come as no surprise when
you consider that energy was the second-most-volatile sector (24
percent average annual volatility) behind financials over the past
That's perhaps more impressive when you account for the fact
that energy did not have a "black swan" event like financials,
where large chunks of the industry disappeared.
Even last year's 2 percent return came with some vicious
swings:XLE was up 7 percent as late as Feb. 24 last year, and ended
up needing a year-end rally to erase what was at one point a
decline of 12-plus percent.
Now that we've established just how volatile energy has been
over the past decade, we can go about determining if the recent
rally has legs and, crucially, if there are any structural changes
taking place in the market that may dampen that volatility moving
The market certainly seems to be saying the answer to the first
question is a resounding yes. Just take a look at some of the
tracking subsectors of the energy market:Don't look now, but the
Market Vectors Oil Services ETF (NYSEArca:OIH) just hit an 18-month
high, while the iShares Dow Jones U.S. Oil & Gas Exploration
& Production Index Fund (NYSEArca:IEO) is trading at a level
not seen since last March.
Meanwhile, the best ETF proxy for gasoline, the futures-based
United States Gasoline Fund (NYSEArca:UGA), is trading at a 52-week
The price action in UGA is especially noteworthy for XLE
investors because XLE is dominated by the massive integrated oil
firms like Exxon Mobil and Chevron.
The stronger the market for gasoline, the more revenue these
firms earn and-all else being equal-the higher the multiple the
market will be willing to place on them.
Of course, I would be remiss if I didn't mention that U.S. oil
production is at a 20-year high, while OPEC is
To put that in context, year-over-year crude oil output in the
U.S. rose by an average 1.3 million barrels a day, which represents
a 22 percent increase. That is a massive jump in production that
disproportionately benefits large oil-producing firms here in the
United States that make up the heart of XLE's portfolio.
In other words, the stage is set for domestic energy companies
to have a fantastic year, if not a fantastic decade.
Meanwhile, volatility in the futures market, as measured by the
CBOE's Oil Volatility Index, just hit the lowest level since
Now this may be a contrarian indicator for those looking to
short the recent run-up in energy prices, but it may also speak to
the structural shift in energy production and transportation under
way here in the U.S.
If all of these signs point to a more consistent, more reliable
U.S. energy sector, the time to get back in may be staring
you in the face.
At the time this article was written, the author held no
positions in the securities mentioned. Contact Paul Baiocchi at
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