Energy stocks have been a real winner in a generally down year for equities. As headlines blared concerns about the ever-increasing prices for crude oil, gasoline, and diesel, it was entirely logical for investors to put their money into stocks that could benefit from those trends.
But now the tide has turned for crude, and to a lesser extent for refined products. Yet a key ETF that many use as a proxy for energy stocks — XLE (Energy Select Sector SPDR) – remains a significant outperformer against both oil and the S&P 500 Index (SPX). As the chart below shows, crude oil futures (CL) have reverted to levels last seen in January, but XLE is about 30% higher than it was at that time. For added reference, SPX is down about 15% in that period.
2-Year Chart, Rolling 1st Month Crude Oil Futures (CL, red/green daily bars, right scale), XLE (blue line, left scale), SPX (purple line)
Source: Interactive Brokers
It is notable that over the past couple of months, XLE continued to rise even as crude went sideways and fell. We see the ETF peaking about 3 weeks ago. At the time, crude was nowhere near its summertime highs and was actually beginning its latest leg lower. XLE is currently about 10% below its mid-November peak, but crude has fallen even further during that timeframe as well.
Commodity-linked stocks can be influenced by either the prices of their underlying products or the general health of the stock market. Neither is anywhere near its high from earlier this year. And while stocks tend to discount the future events, commodities are more likely to factor in shorter-term concerns about supply and demand. It is difficult to make a case for either current or future events being helpful. We have a crude oil market in its normal backwardation and a bond market signaling serious recession concerns. It is hard to think that XLE’s outperformance is the result of especially rosy views about oil prices over the coming months.
This is where it is important to remember that investor preference can be an important wildcard. If enough investors chase performance in a particular sector, it can become self-fulfilling. I believe this is the key element behind XLE’s both its earlier outperformance and its ability to sustain most of its gains. If enough investors allocate money to a sector, it can simply follow that money higher.
It was widely believed that oil stocks had become under-represented in a wide range of institutional and individual portfolios. ESG concerns and a focus on alternative energy sources made oil stocks an anathema to many investors. As the price of oil skyrocketed earlier this year, thanks to a strong economy and the Russian invasion of Ukraine, many investors raced into oil stocks as a way to either hedge or profit from the higher prices. That was certainly the case as XLE and CL rose in tandem through June.
However, after both XLE and CL dipped in early summer, the relationship changed. XLE was able to sustain bigger bounces during the summer and raced to new highs this autumn. Each time SPX bounced off its lows in June and October, XLE bounced more. It is quite obvious that investors gravitated to a sector that had been a rare source of generally sustainable gains throughout the year.
That raises a specter ahead of year-end in a few weeks. If investor preference and performance chasing provide the rationale for XLE’s gains, we can understand why institutional portfolio managers would want to hold onto a winning sector into year-end. Will that preference continue as the calendar turns? If oil can reverse its recent declines, then quite possibly yes. If oil continues its months-long malaise amidst economic concerns, it seems likely that XLE and the energy sector could succumb to the relentless rotation that continually occurs in equity markets.
Disclosure: Interactive Brokers
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