After several months of sitting securely in the top half of the eight broad sector rankings, the major Energy sector plummeted to #6 (of 11) over the past two weeks.

While this doesn’t necessarily mean investors with money in Energy stocks or ETFs should cut and run, it’s a good opportunity to explore why this might be happening and what investors should keep their eyes on in the future.

When the Energy sector made it up to #3, it was the result of the sector gaining strength very quickly.  These rankings don’t shift around very easily. So the fact that Energy quickly made it up to the upper rankings says a lot. And the fact that it dropped quickly to #6 says a lot, too.

Any sector ranked #3 is considered as a leader.  Why the “here today, gone tomorrow” behavior?

It’s simple.  This is how sectors behave when they are trying to become a leader.  

Technology and Financials have been confirmed leaders for years.  You won’t see them shifting around like this. Energy could be establishing itself as a leader…or maybe not. And this is what the stock market is all about – you can buy something very early in its newly established bullish trend – but for that early entry price, the risk of a false start or a fake out is certainly elevated.  The payoff for that risk if it works is the fact that the earliest price-advances tend to be the sharpest. Aggressive, fast pace, higher risk/reward investors enjoy this type of scenario.

Rowe Wealth Management differs from the vast majority of investment advisors because instead of the “buy and hope” approach, we incorporate tactical money management strategies.  That is, we buy our clients what is working on a long-term basis and we sell what’s not. Active money management is our preference.

Relative Strength analysis determines a sector’s long-term performance potential.

Taking this into account, it probably won’t come as a surprise that Energy’s problems began several months ago and have continued to build up to the present date.

Of course, Energy, as a Major stock market sector, is very closely tied to Crude Oil prices.

Looking back at the last week of May 2018, we can see that oil prices declined sharply when Saudi Arabia and Russia announced plans to ease their oil production cuts in response to oil supply shortages from Venezuela. West Texas Intermediate crude dropped 4% that week, settling at $67.88 per barrel.

Continuing into July, West Texas crude futures fell again, despite predictions for strong energy demand through the end of the year. Hedge funds trimmed bullish wagers on U.S. crude, cutting combined futures and options positions in New York and London by over 11,000 contracts in the week of July 24.

It’s worth noting that overall crude oil prices have continued to rise, but any optimism has been at least partially squelched by worries that U.S. oil supply is tightening.   

This theme of U.S. oil supply concern continues to carry through into the present day. Although oil prices experienced a five-session climb over the past week, mainstream publications such as The Wall Street Journal and MarketWatch continue to publish pieces that carry an ominous tone and warn about falling U.S. crude inventory.

We can even see the effects of this diminishing inventory in day-to-day life with gas prices rising sharply throughout the country. Energy analysts recently predicted a fall of about 3.4 million barrels of crude inventory, but that estimate was dwarfed by a report the Energy Information Administration released last week, which revealed that supplies had fallen by about 5.8 million barrels.

However…although tightening oil supplies have certainly led to some uncertainty in the market, this could actually be a good thing for U.S. Energy in the long run.

There’s a decent amount of talk about the recent U.S. trade sanctions on Iran and the economic state of Turkey, both important players in oil production and transport in the middle east.

Depending on what happens between now and November, when the sanctions are scheduled to take effect, U.S. oil prices could push higher, eventually driving Energy back up. Investors are already starting to bet on crude again, both because of tensions with Iran and due to the drop in U.S. oil supply.

Investors would also be wise to keep an eye on the status of the U.S. tariff negotiations with China. The U.S. has already imposed heavy tariffs on Chinese goods (totaling around $50 billion) and if this leads to increased tensions and a disruption of the global economy, oil demand could push even higher, pushing the stock market’s major Energy sector higher as well.

So, at the end of the day, uncertainty about falling supply seems to be a big factor in the Energy sector drop-off, but there’s also an equal amount of evidence suggesting that this will eventually become a positive factor for U.S. energy.

Depending on what happens in the future with tariffs and the possibility of “trade wars”, U.S. oil could continue to see increased demand and higher prices.

There is overwhelming evidence that investing is most effective when the focus isn’t just on “stocks” and “bonds” and “commodities”, but when the focus is narrowed down to the strongest sectors.  

Instead of U.S. stocks, International stocks, bonds, and commodities, we’re focused on:

If your investment advisor isn’t focusing, first, on which sectors are leading and should therefore be over-weighted in your portfolio, you may want to give us a call.

We offer free consultations to investors with portfolios valued over $500,000. Here’s the link to set your’s up.  

As always, invest wisely.