Oil's Rout Ripples Beyond Energy ETFs

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S harp drops last week in the major market indexes and many ETFs may have more to do with plunging oil prices than the keenly watched Fed move expected Wednesday.

Benchmark ETFs tracking the S&P 500, Dow and Nasdaq dumped 3% to 4% each. Many exchange-traded funds turned negative for 2015.

Investors are by and large braced for the first rake hike in nearly a decade, which is expected to be a very small one, says Russ Koesterich, BlackRock's global chief investment strategist.

But oil's collapse to levels last seen in 2008-09 is smelling more acrid.

"Paying less at the pump might seem like a good thing, but the drop in crude has reinforced fears over slow economic growth and deflation," Koesterich wrote Monday.

United States Oil ( USO ), the most popular oil commodity ETF, has given up 20% in the past month as WTI crude, the U.S. benchmark, fell briefly below $35 a barrel. Year to date, it's down roughly 45% after falling an almost equal amount in 2014.

The latest rout in oil prices followed a contentious Organization of the Petroleum Exporting Countries (OPEC) meeting Dec. 4 that failed to agree on production cuts. Major members of the oil cartel are aggressively pumping out oil to shut out growing rivals such as the U.S. and Russia.

The resulting global supply glut has gutted commodity prices.

Pain Spreads

And investors are turning more wary about a bet on energy ETFs for successful investing .

Energy Select Sector SPDR ( XLE ) has slumped 22% for the year through Dec. 11.

ETFs focusing on oil and gas producers or small-cap energy stocks have fared worse. They're off 33% to 46% so far this year.

Even energy infrastructure master limited partnerships (MLPs) that focus more on "midstream" pipeline and storage companies are hurting.Alerian MLP ( AMLP ) has fallen 20% in the past month and 37% YTD.

Duncan Rolph, a partner at Miracle Mile Advisors, recent added energy exposure to portfolios with XLE. The ETF's two biggest holdings areExxon Mobil ( XOM ) andChevron ( CVX ), but it also has sizable stakes in smaller storage, transportation and equipment companies.

Rolph likes that diversification, as well as XLE's 2.92% yield. It's also a less volatile way to own oil than an ETF such as USO, he said.

"While energy prices may continue to suffer short-term bouts of volatility, the low entry point makes it an attractive longer-term investment," Rolph said. But he's avoiding MLPs, which are vulnerable to rising rates.

MLPs generally depend more on the volume of products transported than on commodity prices.

But they're not immune to the drop in oil prices, Koesterich said.

"Fears concerning the MLP space were exacerbated whenKinder Morgan (KMI), an energy pipeline company, announced it was slashing its dividend by 75%" on Dec. 8, he added.

Other asset classes tied to energy are faring poorly too. "The collapse in oil prices is reviving fears over energy issuers in the high-yield market," Koesterich wrote.

On Friday, news that a high-yield bond mutual fund was halting shareholder withdrawals as it liquidated holdings rattled investors.

Currencies of oil-exporting nations, such as Mexico, Russia and Columbia, are also under renewed pressure, Koesterich said.

Vanguard FTSE Emerging Markets (VWO) is down 20% YTD.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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