Oil has surged this year and energy stocks have rallied, but interest in the sector continues to shrink day by day. The weighting of energy equities within the S&P 500 is at its lowest level since at least 1990, according to Bloomberg—last standing at a mere 4.87%.
That makes energy the fourth-smallest sector, ahead of only utilities, real estate and materials.
Energy’s fall from grace has been shocking. Eleven years ago, in June 2008, energy’s weighting in the S&P 500 peaked at more than 16%, putting it neck and neck with the weighting of technology. Peak oil, the rise of China and a lack of spare production capacity within OPEC countries were the themes of the times.
Energy topped out with the second-largest weighting in the S&P 500 before the financial crisis took the legs out from under the entire market. But unlike other sectors that have come back strong over the past decade, energy has only limped along begrudgingly.
The largest energy ETF on the market, the $12 billion Energy Select Sector SPDR Fund (XLE), is nearly 40% below its all-time high, as the S&P 500 is close at its highest level ever.
There have certainly been brief moments of strength for the sector, such as in 2014, when triple-digit oil prices pushed XLE to a record, but for the most part, energy is the black sheep of the stock market, overlooked for much trendier and more promising groups such as technology, communication services and health care.
It’s not hard to understand why energy has underperformed. The fracking revolution in the U.S., which pushed the country’s oil production up 2.5x and the country’s natural gas output up 0.5x since 2008, has inundated the world with supply.
At the same time, a systematic movement to conserve energy and to transition to renewables in response to high fossil fuel prices and climate change concerns slowed demand growth significantly.
All the while, energy companies have thrown good money after bad, taking a growth-at-all-cost mentality, when it clearly wasn’t the prudent thing to do. In 2016, the energy sector’s proclivity toward debt-fueled growth sent many firms into bankruptcy and sunk the entire junk bond market with them.
Energy’s woes are reflected in the numbers. Over the past decade, energy ETFs have dramatically underperformed the broader markets.
XLE, for example, is down 26.8%, and up 62.9% over the past five and 10 years, respectively. That compares with a gain of 68.8% and 290.6%, respectively, for the S&P 500 in those same periods.
10-Yr Returns For XLE (Blue) & S&P 500 (Orange)
Oil and natural gas prices have done even worse than energy equities, and ETFs tied to energy commodities have performed the worst, hobbled by poor performance in the underlying commodities and negative roll yields from contango.
|Ticker||Name||YTD Return (%)||5-Yr Return (%)||10-Yr Return (%)|
|XLE||Energy Select SPDR Fund||10.8||-26.8||62.9|
|AMLP||Alerian MLP ETF||20.0||-21.2||25.2|
|XOP||SPDR S&P Oil & Gas Exploration & Production ETF||-6.5||-66.4||-16.1|
|USO||United States Oil Fund||21.6||-68.9||-65.7|
|UNG||United States Natural Gas Fund||-19.6||-77.3||-95.3|
|Spot Crude Oil Prices||25.2||-44.9||-10.6|
|Spot Natural Gas Prices||-21.3||-41.5||-36.9|
Data measures total returns through July 17, 2019
Going forward, it’s hard to imagine that the fortunes of the energy sector are going to improve in any sustained way. OPEC’s production cuts over the past three years have merely been a bandage over a market awash with oil.
On the demand side, consumption in developed countries peaked more than a decade ago, though total global demand continues to be carried higher by emerging markets. As electric cars become more prolific, emerging market demand may peak too, marking the official end of the oil era.
Natural gas, which sits near record inflation-adjusted lows due to seemingly limitless supplies, will be of little help in boosting the energy industries’ fortunes. Energy scarcity has been replaced by energy abundance.
Of course, oil and natural gas aren’t going to disappear overnight. They are still two of the most important commodities in the world. The boom/bust cycle hasn’t ended either, and periods of low prices and underinvestment can lead to temporary shortages and higher prices.
When that happens, energy stocks and ETFs could rally, lifting the sector’s weighting in the market briefly. Just don’t expect it to last.
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