Sector rotation is an investment strategy based on the reality that some sectors will perform better than others but then will fall out of favor in the business cycle. Managers will buy sectors that are about to come into favor and sell them when the sector’s performance peaks. The following is a list of sectors and the ETFs that track them:
XLE Energy Sector
XLY Consumer Discretionary
XLV Health Care
XLK Technology
XLB Materials
XLC Communications Services
XLRE Real Estate
XLI Industrial
XLF Financial
XLP Consumer Staples
XLU Utilities
Twenty-four days after the bottom of the Corona crash, I captured a snapshot of the performance of the sectors.
On 9/8/2020, the snapshot is below:
The energy sector has gone from the top spot to the bottom spot. But why and what is the outlook for the sector?
According to the Charles Schwab website, there is a massive supply/demand imbalance in oil from the economic downturn due to COVID. But oil production has been slashed for months now, and as the economy reopens, the demand should stabilize. The speed of the recovery of the economy is uncertain, however.
Many articles discuss the cut in oil production. In May and June, OPEC and its allies agreed to cut oil production by 9.7 million barrels a day.[1] In August, the cuts eased by 1 million barrels per day.[2] Additionally, Saudi Arabia has ended its cuts according to the IEA website in an article titled Oil Market Report – August 2020.[3] So although there were cuts in oil production from key players, there is now a movement to relax restrictions.
But what about the oil demand? From what I have read, the recovery for the need for oil is slow. According to the World Oil website, the recovery will take to at least 2022 [4] , and the oil price website indicates that the demand in 2020 will drop 9.1 million barrels per day.[5]
For the demand for oil to increase, the economy has to recover so that people start driving more and buying more products that use oil to make them (i.e., plastics).
The good news is the unemployment rate has decreased from its low of 14.7 percent[6] to 8.4 percent in August[7]. With more people working, there should be more driving, and people should be buying more petroleum-based products. But, the movement to work from home reduces the use of oil because people will drive and fly less. However, there is a limit to how many people can do from home because only 40 percent of jobs can be work from home jobs.[8] Additional pressures on the oil demand are wind farms, solar plants, and electric cars.
The largest driver for demand in oil is becoming plastics:[9]
“Petrochemicals, which make up 99% of all plastics, are the versatile building blocks of modern life. Derived from petroleum and fossil gas, they are found in clothes, paper, fertilizers and cleaning products — and even food preservatives and medicine.
Petrochemicals are rapidly becoming the largest driver of global oil consumption, a report by the International Energy Agency found in 2018. They are set to account for a third of the growth in demand to 2030 and half of the growth to 2050, ahead of trucks, planes and ships.”
So the reduction in demand and glut in the supply of oil due to the COVID crisis is the main driver for the low performing energy sector. The economy is improving, which will increase demand, but there are trends and disruptive forces that are contrary to demand oil.
On the TD Ameritrade website, I have access to analysts’ opinions on the energy sector ETF XLE. 3 Analysts rate the ETF as an avoid or sell. But for the company Exxon Mobile which is a stock I bought in the crash, the ratings are mostly neutral or hold. However, there is a 48 billion shortfall for the company, and the company may have to restructure.
That’s all for now. If you need some interesting financial books to read that will help you with your financial goals check out my books below.
See you in the next blog,
Dr. Paul Keller
The Financial Master Series Books
The Beginner’s Guide to Rental Property Investing
References
[1] https://www.cnn.com/2020/06/06/investing/opec-oil-opec-production-cuts/index.html
[2] https://www.reuters.com/article/us-oil-opec-survey/opec-august-oil-output-rises-for-second-month-as-cut-eased-survey-idUSKBN25S5JO
[3] https://www.iea.org/reports/oil-market-report-august-2020
[4] https://www.worldoil.com/news/2020/8/14/major-forecasters-agree-no-oil-demand-recovery-until-at-least-2022
[5] https://oilprice.com/Energy/Crude-Oil/OPEC-Admits-That-2020-Oil-Demand-Is-Worse-Than-Expected.html
[6] https://www.cnbc.com/2020/05/19/unemployment-today-vs-the-great-depression-how-do-the-eras-compare.html
[7] https://www.cnn.com/business/us-economic-recovery-coronavirus
[8] https://www.theatlantic.com/health/archive/2020/05/work-from-home-pandemic/611098/
[9] https://www.dw.com/en/plastic-oil-petrochemicals-coronavirus/a-52834661
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source https://drpaulkeller.com/sector-1/
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